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THIS REPORT WAS PREPARED BY DANIELA GAMEIRO A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND
ECONOMICS EXCLUSIVELY FOR ACADEMIC PURPOSES THIS REPORT WAS SUPERVISED BY ROSAacuteRIO ANDREacute WHO REVIEWED THE
VALUATION METHODOLOGY AND THE FINANCIAL MODEL (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT)
See more information at WWWNOVASBEPT Page 137
MASTERS IN FINANCE
E R
EDP is currently increasing its installed capacity in
green energy sources In Iberia it is expected an increase
of installed capacity in hydro from 3627 MW in 2015 to
7170 MW in 2019 In Brazil we expect an increase of 29
during the same period Additionally EDPR has a plan to
increase its portfolio of wind and solar of approximately 06
GW in the upcoming years
PPACMECrsquos stable gross profit is coming to an
end shifting its operations to the liberalized market It is
expected that the EBITDA of the segment will decrease
from euro674 million to euro118 million in the period 2014-2019
Brazil ndash the drought that the country is going
through is abnormal and we think that the situation will
reverse hence benefiting EDPrsquos new hydro projects
Spain and Portugalrsquos officials are putting every
effort to reduce the tariff deficit in order to end with the
situation in 2020 as it is expected by the European
Commission
Every operating segment has a positive NPV
Company description
EDP is the largest utility company in Portugal and one ofthe largest energy operators in the Iberian market EDPoperates in the electricity and gas market throughgeneration distribution and supply It also owns 775 ofEDP Renewables and 51 of EDP Brazil operationsthrough generation distribution and supply of electricity
EDP - ENERGIAS DE PORTUGAL COMPANY REPORT
UTILITIES SECTOR 3 JUNE 2015
STUDENT DANIELA GAMEIRO danielagameiro2013novasbept
Recommendation HOLD
Price Target FY15 354 euro
Price (as of 29-May-15) 356 euro
Reuters EDPLS Bloomberg EDPPL
52-week range (euro) 304-375
Market Cap (eurom) 12999
Outstanding Shares (m) 3657
Source EDP
Source Bloomberg
2014 2015E 2016F
EBITDA (eurom) 3642 3677 3655
Net Profit (eurom) 1264 1111 1105
Net DebtEquity 148 150 142
Net DebtEBITDA 486 501 490
EPS 035 030 030
PE 1029 1116 1172
Dividend Yield () 520 634 558
Source Company Data and Analystrsquos estimates
Reducing the Carbon Footprint
By becoming Greener and Greener every yearhellip
0
50
100
150
fev-10 out-10 jun-11 fev-12 out-12 jun-13 fev-14 out-14
PSI20 Index
EURO STOXX UTILITIES PRICE
EDP PL Equity
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 237
TABLE OF CONTENTS
EDP OVERVIEW 3
COMPANY DESCRIPTION 3
SHAREHOLDERS STRUCTURE 5
BUSINESS FRAMEWORK 6
MACROECONOMIC CONTEXT 6
GLOBAL ENERGY TRENDS 6
REGULATORY CONTEXT 9
VALUATION PRINCIPLES10
ELECTRICITY GENERATION IN IBERIA 13
LONG - TERM CONTRACTED GENERATION14
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR) 16
ELECTRICITY SUPPLY IN IBERIA21
ELECTRICITY DISTRIBUTION IN IBERIA23
GAS IN IBERIA 26
BRAZILIAN OPERATIONS 28
GENERATION AND SUPPLY 28
DISTRIBUTION32
NON-HYDRO RENEWABLES SECTOR33
FINAL CONCLUSIONS34
SUM-OF-THE-PARTS34
SENSITIVE ANALYSIS34
APPENDIX 35
DISCLOSURES AND DISCLAIMER 37
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 337
Generation
Distribution
Supply
Generation
EDP OVERVIEW
COMPANY DESCRIPTION
EDP ndash Energias de Portugal was created in 1976 after the fusion of thirteen
nationalized companies The privatization process began in the year 1997 when
the company made its IPO and since then EDP has been listed in NYSE
Euronext Lisbon
EDP has established itself as a vertically integrated business which owns
diversified operations in major areas of the energy industry The firm has its
business structured in three main operating divisions Iberia EDP Renewables
and EDP Brazil The core business of the company is mainly based in the Iberian
market where EDP operates in the generation distribution and supply of
electricity and supply and distribution of gas The firm also operates around
the world through EDP Renewables which similarly to EDP is listed in NYSE
Euronext Lisbon EDP owns 775 of this company which operations are tied to
the generation of electricity in 11 different countries through the use of renewable
sources of energy such as the wind and the sun Additionally EDP owns 51 of
EDP Brazil which is listed in the New Market of the Stock Exchange of Satildeo Paulo
The firm has operated in this country since 1996 in the segments of generation
supply and distribution of electricity
As it can be seen in figure 2 a large part of the EBITDA generated by EDP in
1Q2015 (euro1017 million) belongs to the regulated (31) and renewables (31)
segments These units have lower exposure to market risk due to the fact that
they operate under a business environment controlled by regulators but they are
subject to risks tied to possible unfavorable decisions taken by these external
regulating entities On the other hand the liberalized segment is exposed to the
market (having a 10 share of the total EBITDA of the company)
Currently EDP is one of the major European energy operators and is the largest
Portuguese industrial group having had a slow but steady growth over the past
years as it can be seen in figure 3
By looking at five of the most used financial ratios to financially evaluate
companies some conclusions can be taken regarding EDP and its ldquoclosest
peers1rdquo i) EDP can be considered an attractive investment since its ROE is within
15-202 but it still has a ROE 10 percentage points lower than the one presented
by Endesa ii) its ability of using assets to generate earnings measured by the
1More information regarding EDPrsquos peers in Appendix 1
2In general financial analysts consider an ROE in 15-20 range to represent attractive levels of investment quality ndash Source Investopedia
Figure 1 Lines of Business
Figure 2 EBITDA Breakdown () ndash 1Q2015
Source Company Data
15
10
31
31
12
-1
LT Contracted GenerationLiberalised Activities IberiaRegulated Networks IberiaWind amp Solar PowerBrazilOther
Table 1 ndash Operating Data
Financial Year 2014
Installed Capacity (MW) 22469
Electricity Distributed (GWh) 79428
Electricity Generation (GWh) 60220
Gas Distributed (GWh) 53846
Clients connected (th) 9894
Employees 11798
Source Company Data
EDP SA
EDP RenewablesIberia EDP Brazil
Generation
Distribution
Supply
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 437
ROA is below the equivalent ability of its two most direct peers iii) EDP has the
highest EVEBITDA but also the lowest PE
Regarding leverage EDP has defined as one of its strategic goals for the
business cycle beginning in 2014 and ending in 2017 to undergo a financial
deleveraging process so that it is able to improve credit ratios and mitigate
business risk As it can be seen figure 4 shows a commitment to this objective
Despite the focus in improving its credit metrics EDPrsquos ratings attributed by the
three most important global rating agencies havenrsquot still improved significantly
The main reasons that have led these agencies to be reticent in upgrading EDPrsquos
rating are tied to the current tariff deficit in Iberia3
as well as the economic
recession that has affected Portugal and Spain in the past few years
However due to the latest debt policy which was undertaken by the company
EDP has been recently slightly upgraded into an ldquoInvestment Graderdquo status The
cause for the upgrade was also tied to the stabilization of the tariff deficit the
lower likelihood that more regulatory cuts will be needed and the increasing
diversification of the companyrsquos operations
Most of the EDPrsquos debt (72) is in Euros being the rest denominated in foreign
currency This debt allocation creates a dynamic in which a higher foreign
currency appreciation will reduce part of the euro value of the debt
As part of its strategic plan EDP is also basing a great chunk of its future growth
on CO2-free technologies namely wind and hydro As it can be seen in figure 6
the growth capex is mainly focused on wind and hydro Regarding wind and solar
EDPrsquos expansion is focused in markets with solid profitability and attractive
fundamentals The company is expected to expand its capacity at an average
pace of 500MW per year during the period that begins on 2014 and ends in 2017
In Portugal EDP has an ongoing expansion plan in new hydroelectric capacity
3See section ldquoBusiness Frameworkrdquo for further detail on this subject
Figure 3 - EBITDA (million euros)
Source Bloomberg
0
2000
4000
6000
8000
2010 2011 2012 2013 2014
Endesa Iberdrola EDP
Table 2 Financial Ratios ndash Average 2014
Endesa Iberdrola EDP
ROE 2294 658 1215
ROA 770 253 245
EBITDA Margin 1617 2289 2240
EVEBITDA 848 874 911
PE na 1329 1193
Source Bloomberg
Figure 5 EDP consolidated debt by
currency () ndash 2014
Source Company data
EUR72
PLN1
USD22
BRL5
Figure 4 Credit Metrics
Source Company Data
60 61 60 59 58
17 15 14 1412 11 9 10
0
50
100
2012 2013 2014 2015 1Q15
Leverage FFONet Debt
Table 3 SampP Rating vs Peers
Company Country Rating
EDP Portugal BBB-
Iberdrola Spain BBB
Endesa Spain BBB
EOn Germany A-
EDF France A+
Centrica UK A-
Enel Italy BBB
Source Bloomberg ndash 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 537
Figure 7 Shareholder Structure
Source EDP (update 21-05-2015)
ChinaThree
Gorges(CTG)21
CapitalGroup
Companies Inc
15
Oppidum7
BlackRock Inc
5
SenforaBV4
Remaining
shareholders48
which includes an investment of euro23 billion in 22 GW of new capacity allocated to
this type of power generating assets
SHAREHOLDERS STRUCTURE4
EDPrsquos share capital is composed by a total of 3656537715 shares with a
nominal value of 1euro each Since its inception the companyrsquos shareholder structure
has changed significantly making a transition from a state-owned company to a
company in which the state only has a minority interest In order to reach its
current composition EDP had to undergo 8 privatization phases
Currently the company is mainly owned by foreign investors As of 31 December
2014 only 14 of the company was owned by Portuguese entities and the main
percentage of its shares (34) belonged to European entities (excluding Iberia)
In the most recent times (from 2014 onwards) the biggest changes in EDPrsquos
shareholder structure were related with the Capital Grouprsquos5
participation
increase from 5 in 2013 to 1510 in May 2015 and the sale of Iberdrolarsquos
666 stake in the company (partnership that existed since 1998) The decision
by Iberdrola to decrease its position in EDP follows its discomfort regarding the
ceiling of 5 of voting rights that penalized it during the decade that preceded the
sale of EDPrsquos 2135 by the Portuguese state to CTG
The purchase by CTG occurred in December 2012 and the transaction amounted
to euro27 billion (euro345 per share) The transaction was made at 536
premium to
its share price Subsequent to the purchase EDPrsquos share price increased in the
following two weeks from euro233 to euro240
Strategic Partnership with China Three Gorges
CTG is the largest clean energy group in China As EDP CTG is focusing its
expansion plan on renewable energies which means that there may exist
synergies between the plans of the two coompanies EDP and CTG entered in a
strategic partnership where i) CTG will invest euro2 billion which will be spent on
acquisitions of minority stakes and investments related with renewable projects ii)
find a Chinese financial institution to give a credit facility of euro2 billion to EDP for up
to 20 years iii) develop new growth opportunities Until the present moment CTG
has already committed euro1 billion to investments in renewable energy undertaken
by EDP These investments are tied to hydro in Brazil (Satildeo Manoel Jari and
Cachoeira- Caldeiratildeo) and wind in Portugal (1st block and 2nd block)
4Remaining shareholders include shareholders with ownership lower than 3 such as Grupo BCP+Fundo Pensotildees do Grupo BCP (244) Sonatrach
(238) Qatar Investment authority (227) EDP (Treasury Stock) (062)5
Capital Group is one of the largest investment management companies worldwide with assets around USD 1 trillion6
Bugge Axel 2011 China Three Gorges buys EDP stake for 27 billion euros Reuters
Figure 6 2015E-2017E Capacity Additions
( new MW)
Source Company Data
WindPPA
LatAm5
Windothers
8
WindPPAUSA36
HydroPortug
al47
HydroPPA
Brazil4
Table 4 CTGrsquos Highlights - 2014
Installed GenerationCapacity - Hydro
463 GW
China hydro capacity 15
Hydro projects underconstruction
28 GW
Moodys rating Aa3
Source Moodyrsquos
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 237
TABLE OF CONTENTS
EDP OVERVIEW 3
COMPANY DESCRIPTION 3
SHAREHOLDERS STRUCTURE 5
BUSINESS FRAMEWORK 6
MACROECONOMIC CONTEXT 6
GLOBAL ENERGY TRENDS 6
REGULATORY CONTEXT 9
VALUATION PRINCIPLES10
ELECTRICITY GENERATION IN IBERIA 13
LONG - TERM CONTRACTED GENERATION14
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR) 16
ELECTRICITY SUPPLY IN IBERIA21
ELECTRICITY DISTRIBUTION IN IBERIA23
GAS IN IBERIA 26
BRAZILIAN OPERATIONS 28
GENERATION AND SUPPLY 28
DISTRIBUTION32
NON-HYDRO RENEWABLES SECTOR33
FINAL CONCLUSIONS34
SUM-OF-THE-PARTS34
SENSITIVE ANALYSIS34
APPENDIX 35
DISCLOSURES AND DISCLAIMER 37
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 337
Generation
Distribution
Supply
Generation
EDP OVERVIEW
COMPANY DESCRIPTION
EDP ndash Energias de Portugal was created in 1976 after the fusion of thirteen
nationalized companies The privatization process began in the year 1997 when
the company made its IPO and since then EDP has been listed in NYSE
Euronext Lisbon
EDP has established itself as a vertically integrated business which owns
diversified operations in major areas of the energy industry The firm has its
business structured in three main operating divisions Iberia EDP Renewables
and EDP Brazil The core business of the company is mainly based in the Iberian
market where EDP operates in the generation distribution and supply of
electricity and supply and distribution of gas The firm also operates around
the world through EDP Renewables which similarly to EDP is listed in NYSE
Euronext Lisbon EDP owns 775 of this company which operations are tied to
the generation of electricity in 11 different countries through the use of renewable
sources of energy such as the wind and the sun Additionally EDP owns 51 of
EDP Brazil which is listed in the New Market of the Stock Exchange of Satildeo Paulo
The firm has operated in this country since 1996 in the segments of generation
supply and distribution of electricity
As it can be seen in figure 2 a large part of the EBITDA generated by EDP in
1Q2015 (euro1017 million) belongs to the regulated (31) and renewables (31)
segments These units have lower exposure to market risk due to the fact that
they operate under a business environment controlled by regulators but they are
subject to risks tied to possible unfavorable decisions taken by these external
regulating entities On the other hand the liberalized segment is exposed to the
market (having a 10 share of the total EBITDA of the company)
Currently EDP is one of the major European energy operators and is the largest
Portuguese industrial group having had a slow but steady growth over the past
years as it can be seen in figure 3
By looking at five of the most used financial ratios to financially evaluate
companies some conclusions can be taken regarding EDP and its ldquoclosest
peers1rdquo i) EDP can be considered an attractive investment since its ROE is within
15-202 but it still has a ROE 10 percentage points lower than the one presented
by Endesa ii) its ability of using assets to generate earnings measured by the
1More information regarding EDPrsquos peers in Appendix 1
2In general financial analysts consider an ROE in 15-20 range to represent attractive levels of investment quality ndash Source Investopedia
Figure 1 Lines of Business
Figure 2 EBITDA Breakdown () ndash 1Q2015
Source Company Data
15
10
31
31
12
-1
LT Contracted GenerationLiberalised Activities IberiaRegulated Networks IberiaWind amp Solar PowerBrazilOther
Table 1 ndash Operating Data
Financial Year 2014
Installed Capacity (MW) 22469
Electricity Distributed (GWh) 79428
Electricity Generation (GWh) 60220
Gas Distributed (GWh) 53846
Clients connected (th) 9894
Employees 11798
Source Company Data
EDP SA
EDP RenewablesIberia EDP Brazil
Generation
Distribution
Supply
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 437
ROA is below the equivalent ability of its two most direct peers iii) EDP has the
highest EVEBITDA but also the lowest PE
Regarding leverage EDP has defined as one of its strategic goals for the
business cycle beginning in 2014 and ending in 2017 to undergo a financial
deleveraging process so that it is able to improve credit ratios and mitigate
business risk As it can be seen figure 4 shows a commitment to this objective
Despite the focus in improving its credit metrics EDPrsquos ratings attributed by the
three most important global rating agencies havenrsquot still improved significantly
The main reasons that have led these agencies to be reticent in upgrading EDPrsquos
rating are tied to the current tariff deficit in Iberia3
as well as the economic
recession that has affected Portugal and Spain in the past few years
However due to the latest debt policy which was undertaken by the company
EDP has been recently slightly upgraded into an ldquoInvestment Graderdquo status The
cause for the upgrade was also tied to the stabilization of the tariff deficit the
lower likelihood that more regulatory cuts will be needed and the increasing
diversification of the companyrsquos operations
Most of the EDPrsquos debt (72) is in Euros being the rest denominated in foreign
currency This debt allocation creates a dynamic in which a higher foreign
currency appreciation will reduce part of the euro value of the debt
As part of its strategic plan EDP is also basing a great chunk of its future growth
on CO2-free technologies namely wind and hydro As it can be seen in figure 6
the growth capex is mainly focused on wind and hydro Regarding wind and solar
EDPrsquos expansion is focused in markets with solid profitability and attractive
fundamentals The company is expected to expand its capacity at an average
pace of 500MW per year during the period that begins on 2014 and ends in 2017
In Portugal EDP has an ongoing expansion plan in new hydroelectric capacity
3See section ldquoBusiness Frameworkrdquo for further detail on this subject
Figure 3 - EBITDA (million euros)
Source Bloomberg
0
2000
4000
6000
8000
2010 2011 2012 2013 2014
Endesa Iberdrola EDP
Table 2 Financial Ratios ndash Average 2014
Endesa Iberdrola EDP
ROE 2294 658 1215
ROA 770 253 245
EBITDA Margin 1617 2289 2240
EVEBITDA 848 874 911
PE na 1329 1193
Source Bloomberg
Figure 5 EDP consolidated debt by
currency () ndash 2014
Source Company data
EUR72
PLN1
USD22
BRL5
Figure 4 Credit Metrics
Source Company Data
60 61 60 59 58
17 15 14 1412 11 9 10
0
50
100
2012 2013 2014 2015 1Q15
Leverage FFONet Debt
Table 3 SampP Rating vs Peers
Company Country Rating
EDP Portugal BBB-
Iberdrola Spain BBB
Endesa Spain BBB
EOn Germany A-
EDF France A+
Centrica UK A-
Enel Italy BBB
Source Bloomberg ndash 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 537
Figure 7 Shareholder Structure
Source EDP (update 21-05-2015)
ChinaThree
Gorges(CTG)21
CapitalGroup
Companies Inc
15
Oppidum7
BlackRock Inc
5
SenforaBV4
Remaining
shareholders48
which includes an investment of euro23 billion in 22 GW of new capacity allocated to
this type of power generating assets
SHAREHOLDERS STRUCTURE4
EDPrsquos share capital is composed by a total of 3656537715 shares with a
nominal value of 1euro each Since its inception the companyrsquos shareholder structure
has changed significantly making a transition from a state-owned company to a
company in which the state only has a minority interest In order to reach its
current composition EDP had to undergo 8 privatization phases
Currently the company is mainly owned by foreign investors As of 31 December
2014 only 14 of the company was owned by Portuguese entities and the main
percentage of its shares (34) belonged to European entities (excluding Iberia)
In the most recent times (from 2014 onwards) the biggest changes in EDPrsquos
shareholder structure were related with the Capital Grouprsquos5
participation
increase from 5 in 2013 to 1510 in May 2015 and the sale of Iberdrolarsquos
666 stake in the company (partnership that existed since 1998) The decision
by Iberdrola to decrease its position in EDP follows its discomfort regarding the
ceiling of 5 of voting rights that penalized it during the decade that preceded the
sale of EDPrsquos 2135 by the Portuguese state to CTG
The purchase by CTG occurred in December 2012 and the transaction amounted
to euro27 billion (euro345 per share) The transaction was made at 536
premium to
its share price Subsequent to the purchase EDPrsquos share price increased in the
following two weeks from euro233 to euro240
Strategic Partnership with China Three Gorges
CTG is the largest clean energy group in China As EDP CTG is focusing its
expansion plan on renewable energies which means that there may exist
synergies between the plans of the two coompanies EDP and CTG entered in a
strategic partnership where i) CTG will invest euro2 billion which will be spent on
acquisitions of minority stakes and investments related with renewable projects ii)
find a Chinese financial institution to give a credit facility of euro2 billion to EDP for up
to 20 years iii) develop new growth opportunities Until the present moment CTG
has already committed euro1 billion to investments in renewable energy undertaken
by EDP These investments are tied to hydro in Brazil (Satildeo Manoel Jari and
Cachoeira- Caldeiratildeo) and wind in Portugal (1st block and 2nd block)
4Remaining shareholders include shareholders with ownership lower than 3 such as Grupo BCP+Fundo Pensotildees do Grupo BCP (244) Sonatrach
(238) Qatar Investment authority (227) EDP (Treasury Stock) (062)5
Capital Group is one of the largest investment management companies worldwide with assets around USD 1 trillion6
Bugge Axel 2011 China Three Gorges buys EDP stake for 27 billion euros Reuters
Figure 6 2015E-2017E Capacity Additions
( new MW)
Source Company Data
WindPPA
LatAm5
Windothers
8
WindPPAUSA36
HydroPortug
al47
HydroPPA
Brazil4
Table 4 CTGrsquos Highlights - 2014
Installed GenerationCapacity - Hydro
463 GW
China hydro capacity 15
Hydro projects underconstruction
28 GW
Moodys rating Aa3
Source Moodyrsquos
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 337
Generation
Distribution
Supply
Generation
EDP OVERVIEW
COMPANY DESCRIPTION
EDP ndash Energias de Portugal was created in 1976 after the fusion of thirteen
nationalized companies The privatization process began in the year 1997 when
the company made its IPO and since then EDP has been listed in NYSE
Euronext Lisbon
EDP has established itself as a vertically integrated business which owns
diversified operations in major areas of the energy industry The firm has its
business structured in three main operating divisions Iberia EDP Renewables
and EDP Brazil The core business of the company is mainly based in the Iberian
market where EDP operates in the generation distribution and supply of
electricity and supply and distribution of gas The firm also operates around
the world through EDP Renewables which similarly to EDP is listed in NYSE
Euronext Lisbon EDP owns 775 of this company which operations are tied to
the generation of electricity in 11 different countries through the use of renewable
sources of energy such as the wind and the sun Additionally EDP owns 51 of
EDP Brazil which is listed in the New Market of the Stock Exchange of Satildeo Paulo
The firm has operated in this country since 1996 in the segments of generation
supply and distribution of electricity
As it can be seen in figure 2 a large part of the EBITDA generated by EDP in
1Q2015 (euro1017 million) belongs to the regulated (31) and renewables (31)
segments These units have lower exposure to market risk due to the fact that
they operate under a business environment controlled by regulators but they are
subject to risks tied to possible unfavorable decisions taken by these external
regulating entities On the other hand the liberalized segment is exposed to the
market (having a 10 share of the total EBITDA of the company)
Currently EDP is one of the major European energy operators and is the largest
Portuguese industrial group having had a slow but steady growth over the past
years as it can be seen in figure 3
By looking at five of the most used financial ratios to financially evaluate
companies some conclusions can be taken regarding EDP and its ldquoclosest
peers1rdquo i) EDP can be considered an attractive investment since its ROE is within
15-202 but it still has a ROE 10 percentage points lower than the one presented
by Endesa ii) its ability of using assets to generate earnings measured by the
1More information regarding EDPrsquos peers in Appendix 1
2In general financial analysts consider an ROE in 15-20 range to represent attractive levels of investment quality ndash Source Investopedia
Figure 1 Lines of Business
Figure 2 EBITDA Breakdown () ndash 1Q2015
Source Company Data
15
10
31
31
12
-1
LT Contracted GenerationLiberalised Activities IberiaRegulated Networks IberiaWind amp Solar PowerBrazilOther
Table 1 ndash Operating Data
Financial Year 2014
Installed Capacity (MW) 22469
Electricity Distributed (GWh) 79428
Electricity Generation (GWh) 60220
Gas Distributed (GWh) 53846
Clients connected (th) 9894
Employees 11798
Source Company Data
EDP SA
EDP RenewablesIberia EDP Brazil
Generation
Distribution
Supply
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 437
ROA is below the equivalent ability of its two most direct peers iii) EDP has the
highest EVEBITDA but also the lowest PE
Regarding leverage EDP has defined as one of its strategic goals for the
business cycle beginning in 2014 and ending in 2017 to undergo a financial
deleveraging process so that it is able to improve credit ratios and mitigate
business risk As it can be seen figure 4 shows a commitment to this objective
Despite the focus in improving its credit metrics EDPrsquos ratings attributed by the
three most important global rating agencies havenrsquot still improved significantly
The main reasons that have led these agencies to be reticent in upgrading EDPrsquos
rating are tied to the current tariff deficit in Iberia3
as well as the economic
recession that has affected Portugal and Spain in the past few years
However due to the latest debt policy which was undertaken by the company
EDP has been recently slightly upgraded into an ldquoInvestment Graderdquo status The
cause for the upgrade was also tied to the stabilization of the tariff deficit the
lower likelihood that more regulatory cuts will be needed and the increasing
diversification of the companyrsquos operations
Most of the EDPrsquos debt (72) is in Euros being the rest denominated in foreign
currency This debt allocation creates a dynamic in which a higher foreign
currency appreciation will reduce part of the euro value of the debt
As part of its strategic plan EDP is also basing a great chunk of its future growth
on CO2-free technologies namely wind and hydro As it can be seen in figure 6
the growth capex is mainly focused on wind and hydro Regarding wind and solar
EDPrsquos expansion is focused in markets with solid profitability and attractive
fundamentals The company is expected to expand its capacity at an average
pace of 500MW per year during the period that begins on 2014 and ends in 2017
In Portugal EDP has an ongoing expansion plan in new hydroelectric capacity
3See section ldquoBusiness Frameworkrdquo for further detail on this subject
Figure 3 - EBITDA (million euros)
Source Bloomberg
0
2000
4000
6000
8000
2010 2011 2012 2013 2014
Endesa Iberdrola EDP
Table 2 Financial Ratios ndash Average 2014
Endesa Iberdrola EDP
ROE 2294 658 1215
ROA 770 253 245
EBITDA Margin 1617 2289 2240
EVEBITDA 848 874 911
PE na 1329 1193
Source Bloomberg
Figure 5 EDP consolidated debt by
currency () ndash 2014
Source Company data
EUR72
PLN1
USD22
BRL5
Figure 4 Credit Metrics
Source Company Data
60 61 60 59 58
17 15 14 1412 11 9 10
0
50
100
2012 2013 2014 2015 1Q15
Leverage FFONet Debt
Table 3 SampP Rating vs Peers
Company Country Rating
EDP Portugal BBB-
Iberdrola Spain BBB
Endesa Spain BBB
EOn Germany A-
EDF France A+
Centrica UK A-
Enel Italy BBB
Source Bloomberg ndash 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 537
Figure 7 Shareholder Structure
Source EDP (update 21-05-2015)
ChinaThree
Gorges(CTG)21
CapitalGroup
Companies Inc
15
Oppidum7
BlackRock Inc
5
SenforaBV4
Remaining
shareholders48
which includes an investment of euro23 billion in 22 GW of new capacity allocated to
this type of power generating assets
SHAREHOLDERS STRUCTURE4
EDPrsquos share capital is composed by a total of 3656537715 shares with a
nominal value of 1euro each Since its inception the companyrsquos shareholder structure
has changed significantly making a transition from a state-owned company to a
company in which the state only has a minority interest In order to reach its
current composition EDP had to undergo 8 privatization phases
Currently the company is mainly owned by foreign investors As of 31 December
2014 only 14 of the company was owned by Portuguese entities and the main
percentage of its shares (34) belonged to European entities (excluding Iberia)
In the most recent times (from 2014 onwards) the biggest changes in EDPrsquos
shareholder structure were related with the Capital Grouprsquos5
participation
increase from 5 in 2013 to 1510 in May 2015 and the sale of Iberdrolarsquos
666 stake in the company (partnership that existed since 1998) The decision
by Iberdrola to decrease its position in EDP follows its discomfort regarding the
ceiling of 5 of voting rights that penalized it during the decade that preceded the
sale of EDPrsquos 2135 by the Portuguese state to CTG
The purchase by CTG occurred in December 2012 and the transaction amounted
to euro27 billion (euro345 per share) The transaction was made at 536
premium to
its share price Subsequent to the purchase EDPrsquos share price increased in the
following two weeks from euro233 to euro240
Strategic Partnership with China Three Gorges
CTG is the largest clean energy group in China As EDP CTG is focusing its
expansion plan on renewable energies which means that there may exist
synergies between the plans of the two coompanies EDP and CTG entered in a
strategic partnership where i) CTG will invest euro2 billion which will be spent on
acquisitions of minority stakes and investments related with renewable projects ii)
find a Chinese financial institution to give a credit facility of euro2 billion to EDP for up
to 20 years iii) develop new growth opportunities Until the present moment CTG
has already committed euro1 billion to investments in renewable energy undertaken
by EDP These investments are tied to hydro in Brazil (Satildeo Manoel Jari and
Cachoeira- Caldeiratildeo) and wind in Portugal (1st block and 2nd block)
4Remaining shareholders include shareholders with ownership lower than 3 such as Grupo BCP+Fundo Pensotildees do Grupo BCP (244) Sonatrach
(238) Qatar Investment authority (227) EDP (Treasury Stock) (062)5
Capital Group is one of the largest investment management companies worldwide with assets around USD 1 trillion6
Bugge Axel 2011 China Three Gorges buys EDP stake for 27 billion euros Reuters
Figure 6 2015E-2017E Capacity Additions
( new MW)
Source Company Data
WindPPA
LatAm5
Windothers
8
WindPPAUSA36
HydroPortug
al47
HydroPPA
Brazil4
Table 4 CTGrsquos Highlights - 2014
Installed GenerationCapacity - Hydro
463 GW
China hydro capacity 15
Hydro projects underconstruction
28 GW
Moodys rating Aa3
Source Moodyrsquos
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 437
ROA is below the equivalent ability of its two most direct peers iii) EDP has the
highest EVEBITDA but also the lowest PE
Regarding leverage EDP has defined as one of its strategic goals for the
business cycle beginning in 2014 and ending in 2017 to undergo a financial
deleveraging process so that it is able to improve credit ratios and mitigate
business risk As it can be seen figure 4 shows a commitment to this objective
Despite the focus in improving its credit metrics EDPrsquos ratings attributed by the
three most important global rating agencies havenrsquot still improved significantly
The main reasons that have led these agencies to be reticent in upgrading EDPrsquos
rating are tied to the current tariff deficit in Iberia3
as well as the economic
recession that has affected Portugal and Spain in the past few years
However due to the latest debt policy which was undertaken by the company
EDP has been recently slightly upgraded into an ldquoInvestment Graderdquo status The
cause for the upgrade was also tied to the stabilization of the tariff deficit the
lower likelihood that more regulatory cuts will be needed and the increasing
diversification of the companyrsquos operations
Most of the EDPrsquos debt (72) is in Euros being the rest denominated in foreign
currency This debt allocation creates a dynamic in which a higher foreign
currency appreciation will reduce part of the euro value of the debt
As part of its strategic plan EDP is also basing a great chunk of its future growth
on CO2-free technologies namely wind and hydro As it can be seen in figure 6
the growth capex is mainly focused on wind and hydro Regarding wind and solar
EDPrsquos expansion is focused in markets with solid profitability and attractive
fundamentals The company is expected to expand its capacity at an average
pace of 500MW per year during the period that begins on 2014 and ends in 2017
In Portugal EDP has an ongoing expansion plan in new hydroelectric capacity
3See section ldquoBusiness Frameworkrdquo for further detail on this subject
Figure 3 - EBITDA (million euros)
Source Bloomberg
0
2000
4000
6000
8000
2010 2011 2012 2013 2014
Endesa Iberdrola EDP
Table 2 Financial Ratios ndash Average 2014
Endesa Iberdrola EDP
ROE 2294 658 1215
ROA 770 253 245
EBITDA Margin 1617 2289 2240
EVEBITDA 848 874 911
PE na 1329 1193
Source Bloomberg
Figure 5 EDP consolidated debt by
currency () ndash 2014
Source Company data
EUR72
PLN1
USD22
BRL5
Figure 4 Credit Metrics
Source Company Data
60 61 60 59 58
17 15 14 1412 11 9 10
0
50
100
2012 2013 2014 2015 1Q15
Leverage FFONet Debt
Table 3 SampP Rating vs Peers
Company Country Rating
EDP Portugal BBB-
Iberdrola Spain BBB
Endesa Spain BBB
EOn Germany A-
EDF France A+
Centrica UK A-
Enel Italy BBB
Source Bloomberg ndash 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 537
Figure 7 Shareholder Structure
Source EDP (update 21-05-2015)
ChinaThree
Gorges(CTG)21
CapitalGroup
Companies Inc
15
Oppidum7
BlackRock Inc
5
SenforaBV4
Remaining
shareholders48
which includes an investment of euro23 billion in 22 GW of new capacity allocated to
this type of power generating assets
SHAREHOLDERS STRUCTURE4
EDPrsquos share capital is composed by a total of 3656537715 shares with a
nominal value of 1euro each Since its inception the companyrsquos shareholder structure
has changed significantly making a transition from a state-owned company to a
company in which the state only has a minority interest In order to reach its
current composition EDP had to undergo 8 privatization phases
Currently the company is mainly owned by foreign investors As of 31 December
2014 only 14 of the company was owned by Portuguese entities and the main
percentage of its shares (34) belonged to European entities (excluding Iberia)
In the most recent times (from 2014 onwards) the biggest changes in EDPrsquos
shareholder structure were related with the Capital Grouprsquos5
participation
increase from 5 in 2013 to 1510 in May 2015 and the sale of Iberdrolarsquos
666 stake in the company (partnership that existed since 1998) The decision
by Iberdrola to decrease its position in EDP follows its discomfort regarding the
ceiling of 5 of voting rights that penalized it during the decade that preceded the
sale of EDPrsquos 2135 by the Portuguese state to CTG
The purchase by CTG occurred in December 2012 and the transaction amounted
to euro27 billion (euro345 per share) The transaction was made at 536
premium to
its share price Subsequent to the purchase EDPrsquos share price increased in the
following two weeks from euro233 to euro240
Strategic Partnership with China Three Gorges
CTG is the largest clean energy group in China As EDP CTG is focusing its
expansion plan on renewable energies which means that there may exist
synergies between the plans of the two coompanies EDP and CTG entered in a
strategic partnership where i) CTG will invest euro2 billion which will be spent on
acquisitions of minority stakes and investments related with renewable projects ii)
find a Chinese financial institution to give a credit facility of euro2 billion to EDP for up
to 20 years iii) develop new growth opportunities Until the present moment CTG
has already committed euro1 billion to investments in renewable energy undertaken
by EDP These investments are tied to hydro in Brazil (Satildeo Manoel Jari and
Cachoeira- Caldeiratildeo) and wind in Portugal (1st block and 2nd block)
4Remaining shareholders include shareholders with ownership lower than 3 such as Grupo BCP+Fundo Pensotildees do Grupo BCP (244) Sonatrach
(238) Qatar Investment authority (227) EDP (Treasury Stock) (062)5
Capital Group is one of the largest investment management companies worldwide with assets around USD 1 trillion6
Bugge Axel 2011 China Three Gorges buys EDP stake for 27 billion euros Reuters
Figure 6 2015E-2017E Capacity Additions
( new MW)
Source Company Data
WindPPA
LatAm5
Windothers
8
WindPPAUSA36
HydroPortug
al47
HydroPPA
Brazil4
Table 4 CTGrsquos Highlights - 2014
Installed GenerationCapacity - Hydro
463 GW
China hydro capacity 15
Hydro projects underconstruction
28 GW
Moodys rating Aa3
Source Moodyrsquos
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 537
Figure 7 Shareholder Structure
Source EDP (update 21-05-2015)
ChinaThree
Gorges(CTG)21
CapitalGroup
Companies Inc
15
Oppidum7
BlackRock Inc
5
SenforaBV4
Remaining
shareholders48
which includes an investment of euro23 billion in 22 GW of new capacity allocated to
this type of power generating assets
SHAREHOLDERS STRUCTURE4
EDPrsquos share capital is composed by a total of 3656537715 shares with a
nominal value of 1euro each Since its inception the companyrsquos shareholder structure
has changed significantly making a transition from a state-owned company to a
company in which the state only has a minority interest In order to reach its
current composition EDP had to undergo 8 privatization phases
Currently the company is mainly owned by foreign investors As of 31 December
2014 only 14 of the company was owned by Portuguese entities and the main
percentage of its shares (34) belonged to European entities (excluding Iberia)
In the most recent times (from 2014 onwards) the biggest changes in EDPrsquos
shareholder structure were related with the Capital Grouprsquos5
participation
increase from 5 in 2013 to 1510 in May 2015 and the sale of Iberdrolarsquos
666 stake in the company (partnership that existed since 1998) The decision
by Iberdrola to decrease its position in EDP follows its discomfort regarding the
ceiling of 5 of voting rights that penalized it during the decade that preceded the
sale of EDPrsquos 2135 by the Portuguese state to CTG
The purchase by CTG occurred in December 2012 and the transaction amounted
to euro27 billion (euro345 per share) The transaction was made at 536
premium to
its share price Subsequent to the purchase EDPrsquos share price increased in the
following two weeks from euro233 to euro240
Strategic Partnership with China Three Gorges
CTG is the largest clean energy group in China As EDP CTG is focusing its
expansion plan on renewable energies which means that there may exist
synergies between the plans of the two coompanies EDP and CTG entered in a
strategic partnership where i) CTG will invest euro2 billion which will be spent on
acquisitions of minority stakes and investments related with renewable projects ii)
find a Chinese financial institution to give a credit facility of euro2 billion to EDP for up
to 20 years iii) develop new growth opportunities Until the present moment CTG
has already committed euro1 billion to investments in renewable energy undertaken
by EDP These investments are tied to hydro in Brazil (Satildeo Manoel Jari and
Cachoeira- Caldeiratildeo) and wind in Portugal (1st block and 2nd block)
4Remaining shareholders include shareholders with ownership lower than 3 such as Grupo BCP+Fundo Pensotildees do Grupo BCP (244) Sonatrach
(238) Qatar Investment authority (227) EDP (Treasury Stock) (062)5
Capital Group is one of the largest investment management companies worldwide with assets around USD 1 trillion6
Bugge Axel 2011 China Three Gorges buys EDP stake for 27 billion euros Reuters
Figure 6 2015E-2017E Capacity Additions
( new MW)
Source Company Data
WindPPA
LatAm5
Windothers
8
WindPPAUSA36
HydroPortug
al47
HydroPPA
Brazil4
Table 4 CTGrsquos Highlights - 2014
Installed GenerationCapacity - Hydro
463 GW
China hydro capacity 15
Hydro projects underconstruction
28 GW
Moodys rating Aa3
Source Moodyrsquos
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 637
Figure 8 Evolution in Iberia
Source IMF World DataBank
-400
-300
-200
-100
000
100
200
300
Portugal
-200
-100
000
100
200
300
Spain
GDP Growth ()
Population Growth ()
BUSINESS FRAMEWORK
Before providing a segment by segment valuation of EDPrsquos activities we will start
by presenting an analysis of the overall market in which EDP operates In order to
perform this analysis we will focus our interest in the macroeconomic environment
surrounding the company and also on the outlook for specific types of energy
which are tied to the operations of EDP This analysis will provide a general
overview which will allow a better understanding of the assumptions used to value
each of the segments
MACROECONOMIC CONTEXT
In order to better understand the evolution of the demand for the energy produced
by EDP it is necessary to start by evaluating the growth of population and also the
growth of GDP in the countries that are most important for EDPrsquos operations
These countries are respectively Portugal Spain and Brazil The United States of
America (USA) may have an important role
related to the consumption of the energy
produced by EDP Renewables and hence
will also be included on our analysis
As it can be seen in the figures 8 and 9 in the
past three years the GDP growth and the
population growth was low for the countries in
consideration which is tied with the financial
crisis that led to the decrease7
in energy
demand
However for the future we expect that this
trend will change its direction as result of the
expected population growth and economic
growth We expect that this increase will
impact positively the energy demand
produced by EDP
GLOBAL ENERGY TRENDS
In order to fully understand the external forces which will drive the demand for the
main types of energy produced by EDP a brief overview of the issues which may
affect the consumption of each of these types of energy will be given In terms of
7Electricity demand in OECD decreased by 49 on a YoY basis in the 1st quarter of 2009 and 35 in Brazil in the same period (Source IEA)
Figure 9 Evolution in America
Source IMF World DataBank
000050100150200250300350 Brazil
000100200300400 USA
GDP Growth ()
Population Growth ()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 737
Figure 11 Evolution of EUA
Source Bloomberg
0
5
10
15
20
25
30
35
eurot
on
CO
2
EDPrsquos installed capacity the types of energy which have a major relevance for
the company are hydro (34) and non-hydro renewables (36) as can be seen
in figure 10 Although the use of energy through nuclear power by EDP being
residual this type of energy is also relevant to the company due to the fact that it
is used by some of its most important competitors Iberdrola and Endesa In this
sense the outlook for this energy is also going to be provided
RENEWABLES SOURCES
Due to the recent awareness of companies in reducing the CO2 emissions EDP
has been focusing a large percentage of its installed capacity mix in renewables
sources of energy However we think that given the low CO2 prices8 the
producers will have fewer incentives to decrease their emissions and hence slow
down the path of emitting lower values of CO2 advocated by the European Union
The sharp decrease in CO2 prices (figure 11) from the past 7 years are the result
of structural surplus of allowances mainly caused by the decrease in demand as
result of the economic crisis In order to solve this problem the European
Commission expects that carbon prices will increase to euro39tC029in 2020 under
the ldquocost efficientrdquo scenario for meeting the 2020 targets We expect that this
increase in CO2 prices will lead the companies to increase its installed capacity in
renewable sources of energy In this sense we think that the supply of this type of
energy will increase and EDP is no exception since it is now focusing most of its
future growth in hydro and wind as will be explained further in detail in the next
sections
Despite the clear environmental advantage of this type of energy the problem is
that they are highly dependent on weather conditions One cannot be indifferent to
the significant drought that has been affecting Brazil for the past few months
already considered the worst that the country is facing in 84 years The countryrsquos
hydro plants reservoirs levels reached in 2014 the worst index since the 2001rsquo
rationing This scenario negatively impacts the Brazilian electricity sector namely
generators and distributors This scenario has been negatively affecting the EDPrsquos
results as well As it will be thoroughly discussed on the section dedicated to the
valuation of the liberalized activities this draught has a negative effect on the load
factors10
of EDP which will lead to an increase in the production costs of this
energy and penalize EDPrsquos sales However we think that this is a unique
8The CO2 prices are represented by EU Allowances which is carbon credit or pollution permits traded in the EU Emissions Trading Scheme (ETS) Each
EUA represents one ton of CO2 that the holder is allowed to emit9
ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
10ܨܮ =
ௐ
ெ ௐ lowastଷହlowastଶସ Load factor is a measure of energy efficiency since it measures the percentage of real production over the maximum demand
(peak load) over a period
Figure 10 EDPrsquos Installed Capacity () -
2014
Source Company Data
Hydro34
Coal12
Cogeneration
0
CCGT17
Nuclear
1
Non-hydrorenewables36
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 837
Figure 13 EDPrsquos evolution of Electricity Generation
using CCGT
Source Company Data
0
1000
2000
3000
4000
5000
6000
7000
8000
20072008200920102011201220132014
GW
h
Spain Portugal
Figure 12 Global Coal demand by region
Source World Energy OutlookIEA2014
0
500
1000
1500
2000
2500
3000
3500
4000
4500
2010 2015 2020 2025 2030 2035
MT
oe
EU USA China
India Others World
situation and we think that will not perpetuate hence the effect in EDPrsquos results
are short-term
COAL
The growth in the global demand for coal has been experiencing a deceleration
which has been essentially caused by lower gas prices that were originated by the
revolution of shale gas (explained in detail below) This revolution led to a
decrease in the use of coal in the United States (the second largest consumer in
the world) and originated a surplus of gas in Europe As it can be seen in figure 12
it is forecasted that the demand for coal will continue to decelerate until 2040
After observing the figure it is possible to conclude that the decrease in demand
for coal is also going to exist in Portugal and Spain
The fact that the demand for coal is going to decrease can lead us to conclude
that the energy produced through the use of this source is going to slowly lose
relevance as other sources of power such as gas and renewable energies will
continue to gain importance However this loss of relevance is going to happen
slower than expected in Europe due to the fact that currently the prices of coal
are decreasing (mainly as a result of the decrease in its demand)
NATURAL GAS
Regarding natural gas despite the fact that there are prospects of an increase11
in
its demand at a global level the same cannot be said for Europe The increase in
the production of natural gas that has been observed during the last decade and
which has led to a decrease in its price and consequent increase in popularity is
being caused by the use of new technologies and by continuous drilling in shale12
In Europe the demand for natural gas is not evolving as positively as expected
due the fragile economic situation of this continent and to the growth in the use of
renewable energies As it can be seen in figure 13 the decrease in Europe follows
the same trend of EDPrsquos generation of electricity using combined cycle and
natural gas plants
NUCLEAR
Despite EDPrsquos very low installed capacity in this type of energy (1) this is one of
the energy sources which provide the highest load factors (figure 14) since
nuclear power plants only stop its operations for operating maintenance
11At a global level the demand for natural gas is expected to increase more than 50 in the next few decades according to ldquoWorld Energy Outlookrdquo
International Energy Agency 12th November 201412
Drilling in shale takes advantage of large concentrations of liquid natural gas and crude oil that exist on this rock and which have a higher energy value
compared to dry natural gas
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 937
Figure 15 Crude Oil Futures (USDbbl)
Source Investing
000
2000
4000
6000
8000
10000
12000
14000
16000
fev-
08
ou
t-08
jun
-09
fev-
10
ou
t-10
jun
-11
fev-
12
ou
t-12
jun
-13
fev-
14
ou
t-14
Figure 14 EDPrsquos Load Factors - 2014
Source Company Data
0 20 40 60 80 100
Hydro
Nuclear
Coal
CCGT
Cogeneration
Renewables
Additionally nuclear and hydro energy sources are the ones which have the
lowest generation costs due to the absence of CO2 emissions
One could say that EDP would benefit if it had more investments made in nuclear
power plants however we think that those investments will not happen Firstly
EDP has already committed a substantial amount of funds to the expansion in
hydro power plants and a strategy shift does not look likely Secondly the cost of
producing nuclear energy may be about to rise as regulators are turning their
attention to the possible environmental consequences of producing this type of
energy (such as the ones that resulted from the accident at Fukushima)
OIL
In the most recent times the oil market has been changing due to the volatility that
social and political turmoil in the MENA region has created Recent events in
countries situated in this geographical area have created unstable geopolitical
issues which may at any moment cause the price of the petroleum to rise
However in the most recent months Brent prices have been decreasing13
and
have inclusively reached the levels that were only verified in 2009
It is impossible to forecast if the decrease in Brent prices caused by the decision
of OPEC will persist in the near future However such low prices are definitely
going to stimulate the demand for this source of energy and will probably
decelerate the current shift into cheaper and less polluting sources of energy
(negative effect on the demand natural gas)
REGULATORY CONTEXT
TARIFF DEFICIT
The major regulatory changes that are being made in the energy sector are
related with the electricity tariff deficit14
The gap has been increasing since
demand has remained flatdecreasing (lower revenues) and the tariffs have not
been sufficient to cover the costs (as decided by the governments not to increase
them) In 2013 Spain and Portugal faced a cumulative tariff deficit reaching 3 of
their GDP and the economic crisis contributed to aggravate the situation
13The decrease has happened after OPECrsquos decision (in November of 2014) to sustain a production of 30 million barrels a day despite the oversupply of
this fossil fuel14
Electricity tariff deficit emerged due to consumer tariffs being set below the corresponding costs borne by the energy companies
Figure 16 Evolution of electricity tariff deficit in Spain
Source European Comission
-18
-8
2
12
22 euro Billion
Regulated costs Revenues (primarily access tariffs) Tariff deficit
Figure 17 Evolution of electricity tariff deficit in Portugal
Source European Comission
0
05
1
15
2007 2008 2009 2010 2011 2012 2013 est
euro Billion
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1037
Figure 18 The largest producers of C02
emissions worldwide in 2014 ndash ( of global C02
emission)
Source Statisca
0 5 10 15 20 25
ChinaUSAIndia
RussiaBrazilJapan
IndonesiaGermany
KoreaCanada
Iran
Since EDP has its core business in Portugal and Spain changes in the regulatory
framework will impact EDPrsquos results In fact in recent years the introduction of
several packages and modifications of the revenue model (cuts in remuneration
rate decrease in acceptable costs etc) have impacted the company particularly
in Portugal (as a result of EFAP15
) and Spain (due to large imbalance of the tariff
deficit) We think that this problem will continue to be relevant in the near future
However its impact will decrease as a result of the gradual stabilization of the
macroeconomic environment in Iberia and reduction of the tariff deficit in this area
CO2 Emissions
The governments of several countries have been gaining more awareness16
of the
impacts that the generation of energy from fossil fuels have in the environment
Despite the positive intentions of some governors there are still countries that
refuse to ratify the Kyoto Protocol and refuse to commit to decrease its CO2
emissions On those countries are China EUA and India and this can be
considered a serious problem since these countries are the ones with the highest
percentage of global CO2 emissions as can be seen in figure 18 To add to this
problem there are now countries that once belonged to the Kyoto Protocol which
are leaving now such as Canada which came out very recently Despite the
intention of the countries to achieve the goals proposed and despite the prices
imposed to those countries that pollute it seems this is not being enough to
reduce the pollution generation by CO2 emissions (table 5)
The non-ratification with the established norms and the increase of CO2
emissions will lead to an increase of penalties imposed in the future which will
harm companies and countries that use polluting sources of energy
VALUATION PRINCIPLES
In order to determine the target price of EDPrsquos shares for the year-end of 2015 it
was used the sum-of-the-parts (SOTP) approach which has the ability to
effectively take into account the fact that there exist different levels of risk inherent
to each segment operated by the company Besides the valuation that was
performed to the operating segments which will be described below it was also
considered that there were adjustments relative to the commercial activities that
exist between the subsidiaries of the group (such as sales of one segment of EDP
to other different segment) which had to be eliminated These adjustments were
15EFAP ndash Economic and Financial Assistance Program that was agreed between Portuguese authorities and the European Union and International
Monetary Fund (IMF) in May 201116
For example in September of 2014 the Secretary-General of the United Nations held a summit named ldquoUN Climate Summitrdquo where he invited global
leaders from various Governments corporate businesses and other members of civil society to discuss the measures that can be taken in order to keepglobal temperatures controlled and reduce the value of harmful emissions
Table 5 - Evolution of Co2 emission
(Thousands kt)
2009 2010 Change
China 7692 8287 8
India 1982 2009 1
USA 5312 5433 2
Russia 1574 1741 11
Germany 732 745 2
Brazil 367 420 14
Japan 1101 1171 6
Source The World Bank
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1137
Figure 19 Cost of equity
Source Analystrsquos estimates
696 694632 631
1094
000
200
400
600
800
1000
1200
LiberalizedPT
RegulatedPT
BrazilianOp
allocated to a segment named ldquoholding and other operating adjustmentsrdquo which
also encompasses the activities of the holding firm (EDP SA)
The valuation method used to value the operating segments was the Discounted
Free Cash Flow (DCF) which takes into consideration the future operating free
cash flows that will be received by the firm and discounts them at an appropriate
discount rate The discount rate used was the weighted average cost of capital
(WACC17
) which reflects the opportunity cost that EDPrsquo bondholders and
shareholders will incur weighted by the proportion of the enterprise value that
each of these groups own The only segment in which this approach was not
used was the segment exclusively tied to renewable energies The value of EDP
Renewables was obtained by directly observing its current market capitalization
Regarding the currency in which all the cash flows are expressed we assumed it
to be the euro For the operations in Brazil the estimates of future cash flows
were initially performed in Brazilian Reals due to the fact that the information
available to be analyzed was all denominated in local currency After performing
the estimates and before discounting the future cash flows obtained we converted
them into euros Future FX rates were estimated by using the relative purchasing
power parity principle18
and IMF estimates (see Appendix 2)
In order to estimate the cost of equity (figure 19) inherent to each segment we
used the capital asset pricing model (CAPM)19
The market risk premium which
was used in the performed computations was the same for all the segments and
corresponds to 52720
(this value was taken from a recent empirical study) For
the risk-free rate which measures the highest return possible to be obtained by
EDPrsquos investors in the absence of default and reinvestment risk we considered
the rate yielded by German 10-year government bonds It is important to mention
that instead of using a spot rate for the yield of these bonds it was used a rate
equal to the average of the values observed in the last 4 years Recently these
bonds have registered the lowest historical yields not so much due to their risk
profile but more because of their relative safety when compared to other
European bonds Fundamentally we believe that the recent sovereign debt crisis
has led investors to lose confidence on economies located on the periphery of
Europe which led to a consequent ldquoflight to qualityrdquo in this case a shift of funds
into German bonds The fact that in the most recent months the ECB has
resorted to the implementation of unconventional monetary policies in order to
17 ܥܥܣ =
ାாlowast ௗݎ lowast (1 minus (ݐ +
ா
ାாlowast ݎ
18RPPP formula in this caseܮܤܧ௧= ൬
ଵାగಳ()
ଵାగುೠ()൰lowast ௧ܮܤܧ ଵ
19Capital Asset Pricing Model ܯܣܥ = ݎ + ߚ lowast ܯ
20Aswath Damodaran - Implied ERP on May 1 2015
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1237
Figure 20 Segment Beta
Source Analyst estimates
000 050 100
Generation andSupply - Iberia
Regulated -Iberia
BrazilianOperations
address the threat of deflation has also lead to further distortions on the sovereign
debt yields including the yields of German bonds The use of an average rate with
a 4 year timespan mitigates the effect of these two events
The risk free rate used to compute the cost of equity was the same for all of the
companyrsquos segments since all cash flows are denominated in euros However for
the segments that are tied to operations in Brazil we needed to take into
consideration the fact that there exists a difference in inflation which is
considerably higher in this country when compared to Europe In this sense a
country risk premium (CRP) of 28521
was added to the risk free rate of
segments located in Brazil
In order to estimate the betas we calculated an individual beta for each of EDPrsquos
different segments based on the average of the unlevered betas of comparable
firms22
operating in similar conditions The risk free rate chosen for the
regressions that were ran in order to find the unlevered beta of comparable firms
was once again the yield of German 10-year government bonds and the index
used to recreate the global market was the MSCI Europe which effectively
captures a large and middle capitalization representation across 15 stock markets
located in Europe
For the regulated activities of EDP we used comparables that operate essentially
in the distribution and transmission segment as the systematic risk can be
considered similar For the generation and supply segments we took into
consideration comparables in which a large part of the income is generated from
operations related with these two types of activities The variables used to
compute the cost of equity and cost of debt of the segment named ldquoHolding and
other operating segmentsrdquo were the same ones used in the Iberia segment since
this segment is the one where the intracompany commercial activities are more
relevant As it can be seen in figure 20 the regulated beta is the lowest of the
betas calculated probably due to its lower dependence on the economic cycle
and external free market forces
Regarding EDPrsquos target capital structure23
we assumed that in the long-run it
will tend to be equal to the structure used by comparable firms which is 084
Concerning the cost of debt24
corporate ratings given by the major credit
analysts (table 6) were considered in order to help determine the market
expectation of EDPrsquos implied cost of debt EDPrsquos current credit rating yields an
21Aswath Damodaran ndash ldquoCountry Default Spreads and Risk Premiums ndash January 2015
22Comparalable companies in i) liberalized segment in Iberia Enel Centrica EDF EON GDF Suez RWE Endesa Gas Natural e Iberdrola ii) regulated
segment in Iberia Enagas REE REN National Grid Snam Terna iii) Brazilian operations CIA Paranaense CIA Energeacutetica MG CPFL Energia TractebelEnergia CIA Energeacutetica SP23
Measured in market values24ௗݎ = ݕ minus 1)ݔܦ minus )
Table 6 EDPrsquos credit rating
LT Rating Last Update
SampP BB+ 30-01-2015
Moodys Baa3 13-02-3015
Fitch BBB- 19-01-2015
Source Credit agenciesrsquo websites
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1337
Table 7 Cost of debt
Portugal Spain Brazil
Cost of
debt
614 614 614
Corporate
tax
2950 3000 3400
After-tax
cost of debt
433 430 405
Source Analystrsquos estimates
Figure 21 Estimated nominal WACC
(implicit currency ndash EUR)
Source Analystrsquos estimates
576 574 541 539
779
000100200300400500600700800900
Figure 22 Electricity Generation in Iberia (GWh)in - 2014
Source Company Data
3
5245
0
10
20
30
40
50
60
PPACMEC
SpecialRegime
OrdinaryRegime
OrdinaryRegime
LT Contracted Generation LiberalisedIberia
equivalent probability of default of 038 and a recovery rate equal to 6220
according to Moodyrsquos25
In order to estimate the implicit yield we used as a risk-
free rate the Portuguese 10 year bond which is currently equal to 25726
for all
the segments and the average of the last 3 years of EDPrsquos 10Y CDS rates which
were added to the risk-free rate Through the use of the implicit yield probability of
default and recovery rate it was possible to compute the cost of debt In order to
compute the after tax cost of debt for the different segments we took into
consideration each countriesrsquo tax rate which is presented in table 7
Regarding the growth rate of the terminal value (g) of each of the computed
cash flows we think that EDP will have different long-term growths across each
region However one common principle which we know about this variable is that
it will have to be anchored between the long term inflation and real GDP growth27
of the country in which the subsidiary operates If the segment is growing at a
perpetuity growth rate lower than the long term inflation than it is going to be
consistently destroying its value and eventually lead the subsidiary into
bankruptcy However if the segment is growing in perpetuity at a pace which is
higher than the real GDP growth of the country it will end up overtaking the
countryrsquos economy in terms of size and value which also isnrsquot minimally realistic
Consequently for the growth rate of operations situated in Iberia it was
considered the Eurozone target inflation which is 2 and for the Brazilian
operations it was considered the long term inflation estimated by IMF equal to
475 (see Appendix 2)
The estimated nominal weighted average cost of capital derived for each segment
through the use of the information depicted above can be consulted on figure 21
ELECTRICITY GENERATION IN IBERIA
The electricity generation segment can be divided into two different parts the
ordinary regime (PRO) and the special regime (PRE) Under the ordinary regime
EDP sells electricity in the free market On the other hand the market tied to the
special regime generation works through bilateral agreements between producers
and last resort suppliers Besides the division in ordinary and special regime the
electricity generation segment is also divided in long term contracted generation
and liberalised generation (figure 22) which will both be extensively analysed in
the following sections
25Sharon Ou February 2011Corporate Default and Recovery Rates - 1920-2010 Moodyrsquos Investors Service
26Bloomberg at 29-05-2015
27 ܦܩ ௪௧ = ൫1 + ܦܩ ௪௧൯lowast (1 + ݐ )൧minus 1
Table 8 EDPrsquos type of regimes ndash 2014
GWh share
Ordinary Regime inIberia
32223 54
Special Regime inIberia
997 2
Total EDPsElectricityGeneration
60220 100
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1437
Figure 23
Source Company Data
Figure 25 ndash Gross profit stability assured until
2017 (euro Million)
Source Company Data
0
200
400
600
800
1000
LONG - TERM CONTRACTED GENERATION
During many years the generation of energy was performed under a strict
regulatory framework which was characterized by the existence PPAs28
These
agreements allowed the generation companies to have a steady flow of income
regardless of the volume of electricity which was produced However in the end of
2007 as the process of energy markets liberalisation began to accelerate it was
determined that the use of PPAs should come to an end In order to compensate
the generators the Portuguese Government decided to create a new type of
contract named CMEC mechanism29
(see figure 23)
As the concessions working under this segment end the power plants will be
transferred to the liberalised generation segment As it can be seen in figure 24 in
the past years the installed capacity in this segment has already started
diminishing and in 2027 it will be residual (see more detail regarding the
concession power plants in Appendix 3)
As it has been showed in the description of the compensation schemes 2017 is
the final period in which there is going to be an update of the variables used to
calculate the remuneration generated by them This means that between this year
and 2027 there will not exist any revisions In this sense the remuneration
scheme of this segment is going to be stable between 2017 and 2027 and 2017 is
going to be a crucial year in terms of remuneration determination The base
CMEC has been revised downwards in euro13 million30
changing the annual base
CMEC from euro81 million to euro68 million from 2013 to 2027 as regards to the
Memorandum of Understanding between IMF and the Portuguese authorities
This segment also includes the special regime generation This regime
corresponds to the generation of electricity through biomass mini-hydro and
28PPA ndash Power Purchase Agreement
29CMEC ndash Cost with maintenance of contractual equilibrium
30EDP Investor Day 2012 The decision was made since IMF believed that the market prices used in the contracts were too optimistic and did not reflect
real market conditions
Goal
CMEC Mechanism
NPV of PPA is maintained
2 compensation schemes
Annual GP revisedfrom 2007-2017
Base CMEC=NPVPPAndashNPV Market
GP in mkt gtgtForecasted ne Reality
GP lt Contractrsquosthreshold -gtReimbursmentGP gt Contractrsquosthreshold -gtPayment
In 2007
GP will be stable2007-2017 however
No more adjustments tomkt from 2017 onwards
euro08 billion
To be paid by allconsumers until 2027
In 2017
update of marketforecasts until 2027
Recalculation ofadditional CMEC
until 2027
Figure 24 PPACMEC Evolution of Installed Capacity (MW) from 2007-2027
Source ldquoPPAsCMECs Legislation Packagerdquo Lisbon February 16th 2007
0
1000
2000
3000
4000
5000
6000
7000Fuel
Coal
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1537
cogeneration31
The regulatory framework which currently exists allows this type
of operators to sell electricity to last recourse suppliers that are obliged to
purchase electricity from them and also to other suppliers in the market As it can
be seen in figure 26 this is not the sub-segment that gives the highest value
however it does not destroy it too Hence we think that it is not in PRE that EDP
will tend to focus its growth
As presented in ldquoEDP Overviewrdquo the EBITDA percentage of this segment was
15 in 1Q2015 but will decrease as the concessions will be transferred to other
segment as will be shown below
VALUATION
As it has already been mentioned in the previous section as the concession
contracts of the power plants operating end they will be sequentially transferred to
the liberalized generation segment However for valuation purposes of the
segment it was assumed that from 2017 onwards all the concessions will be
transferred to the liberalized segment (since there will not exist any additional
revisions of market conditions related to CMEC contracts) Since these
concessions would still be receiving funds related with the CMEC base between
2017 and 2027 these funds were taken into account in the computation of the
segmentrsquos value
The gross profit considered for the CMECPPA sub-segment was the one
presented in figure 24 until 2017 and the base CMEC mentioned above until 2027
From 2017 onwards the regulated generation segment will only be represented
by the special regime In order to estimate the gross profit of this segment we
took into consideration future load factors and installed capacity so that future
Gross ProfitGWh could be estimated Regarding the load factors we believe that
there is not any significant external factor which may lead them to change
31Biomass energy by converting biomass into liquid fuels to produce combustible gases or direct combustion produces heat Cogeneration uses the heat
of motor and power plants to generate electricity
Figure 26 Evolution of some metrics of the LT Contracted Generation segment
Source EDP
0
5000
10000
15000
20000
0
200
400
600
800
1000
1200
2010 2011 2012 2013 2014
Ele
ctr
icit
yG
en
era
tio
n(G
Wh
)
Gro
ss
Pro
fit
(euroM
)
CMECPPA (euroM) PRE (euroM) CMECPPA (GWh) PRE (GWh)
From 2027 onwards only special
regime will belong to this segment
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1637
Figure 27 ndash Evolution Gross profit with operatingcosts (euroM)
Source Company Data and Analystrsquos estimates
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
0
200
400
600
800
1000
1200
Gross Profit Operating costs
Figure 28
Price is set
Absorve 1st PRE Production
MIBELIberian Electricity Market
Producers in Iberia sell in the Iberian pool
Total Iberian demand
Total Demand satisfied
YES NO
Energy sold ordered by
marginal cost
Demand = Supply
Price is set
Source Company Data
significantly due to the weight that PRE represents in EDP For Gross ProfitGWh
we estimated them to be inflation updated for the future
Regarding the operating costs32
of the segment since we are estimating them to
be a percentage of the gross profit of the period we assume that they will
decrease from 2017 onwards following the transference of power plants from this
segment to the liberalized one (figure 27)
Regarding the level of capex we estimated it to be essentially related to
maintenance investments which in the future will be lower as the installed
capacity becomes lower (due to the power plants transference) Additionally there
will be disinvestments that correspond to ldquosalesrdquo to the liberalized segment that
can be seen in detail in the segment valuation below
Valuation 1 ndash Long-Term Contracted Generation Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 3001
NOPLAT 500 481 447 392 342 353 305 295 2 42 WACC 576
(+) Depreciation 214 203 210 213 174 157 148 120 114 2g Op Value
200
Operating Gross Cash Flow 714 683 657 605 516 510 453 415 115 44 768(-) Capex -96 -59 -35 352 -46 206 -40 1284 -2
Disinvestment Capex 0 0 9 390 0 252 0 1323 0
Maintenance Capex -96 -59 -44 -38 -46 -46 -40 -40 -2
(-) Change in NWC -188 79 -20 -46 0 -32 0 -199 0
Operating Free Cash Flow 400 678 550 822 464 627 375 1200 42
LIBERALISED GENERATION (EXCLUDING WIND AND SOLAR)
Out of all of EDPrsquos segments the liberalized generation of electricity in Iberia
excluding wind and solar is the one which has the highest growth in installed
capacity This growth is mainly focused on hydro-related projects and it is going to
result on an installed capacity increase from 7777 MW in 2014 to 13705MW in
2018 in which hydro represents 52 Looking at other segments of EDP it is
possible to conclude that although Brazil has the second highest installed capacity
(2158MW in 2014) it is still not close from reaching the Iberia liberalized
generation installed capacity One of the main ideas behind the focus that is being
given to hydro is to reap the benefits from low dependence on oil prices and also
CO2 emissions as already mentioned in the ldquoBusiness Frameworkrdquo section
In the liberalized market the price which producers receive is equal to a residual
price and not an average market price (see figure 28)
As it can be seen in figure 29 in the past three years variables costs33
have been
decreasing essentially due to decrease in generation costs34
which have
decrease at a rate of 20 a year The major energy source that has led to this
decrease is the hydro generation costs that were euro26MWh followed directly by
32In this report when mentioning operating costs we are referring to supplied and services personnel costs costs with social benefits and other operating
costs (revenues)33
Variable costs include fuel costs CO2 costs hedging results system costs34
Generation costs include fuel costs CO2 emissions and hedging results Hedging results are gains from hedging strategies of EDP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1737
Figure 31 - Market shares in the IberianPeninsula ndash Electricity Generation
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural
Others
2013 2012
low nuclear generation costs at euro48MWh The nuclear and hydro energy sources
are the ones which have the lowest generation costs due to the absence of CO2
emissions These two sources of energy can be considered the most profitable
ones contrary to CCGT and coal which generation costs in 2014 were
euro1067MWh and euro38MWh respectively Hence if there is still demand to be
satisfied in the pool they are the last sources of energy to be called into
Additionally it can be concluded that the average selling price35
of energy has
been regular which means that the gross profit has mainly been influenced by the
generation costs We will put more emphasis to this gross profit component
Although EDP is currently increasing the installed capacity which is using to
produce hydro energy it is vital to analyze the load factor of this source of energy
and compare it to load factor of other types of energy in order to understand the
extent to which this capacity expansion can benefit the company This variable
varies depending on the amount of load and the amount of time that the
generator is operating and it can be used as proxy to measure efficiency and
generation costs
In order to understand how EDPrsquos investment in hydro can benefit the company
(or not) in the near future we think that it is necessary to make a comparison of
load factors with its peers of the Iberian liberalized generation segment In order to
choose those peers we looked for companies with similar relevance and market
share in Iberia The two chosen companies were Endesa and Iberdrola (figure 31)
In the figures that are shown below (figure 32 and 33) it can be observed each
companyrsquos distribution of installed capacity over the different types of energy
sources and also the value of the load factors for each type of energy Only data
from Portugal and Spain electricity generation was taken into consideration both
for EDP and its peers since only the factors from the Iberia area can influence the
generation of electricity of EDP in this area
35Average selling price includes selling price ancillary services and others
Figure 29 ndash Evolution of Gross Profit and its Components (euroMWh)
Source Company Data
472 474432
63 631 595
158 157 163
0
20
40
60
2012 2013 2014
Variable Cost Average Price
Electricity Gross Profit Generation Output
Electricity purchases Retail - final clients
Wholesale market
Figure 30 Generation Costs
Source Company Data
0
20
40
60
80
100
2012 2013 2014
CCGT Coal Hydro Nuclear
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1837
Figure 34 LCoE at 10 discount rate
Source EIA
35 30 30 4565
200
30
60 63 50
140 100
70
0
50
100
150
200
250
Minimum Maximum
Figure 35 Liberalized Generation in Iberia
Source Company Data
0
5000
10000
15000
20000
25000
0
200
400
600
800
1000
20102011201220132014
Ele
ctr
icit
yG
en
(G
Wh
)
EB
ITD
A(euro
M)
LT Contr Gen (GWh)
Lib Iberia (GWh)
LT Contr Gen (euroM)
Lib Iberia (euroM)
As it can be seen in the figure the energy source which has the highest load
factor (independently of the installed capacity) is the energy produced in nuclear
power plants As it was already mentioned this is due to the fact that nuclear
power plants only stop its operations for operating maintenance On the other
hand despite the high percentage of installed capacity of Iberdrola and EDP in
hydro the load factor achieved in 2014 was approximately 25 mainly due to the
dependence of these plants on weather conditions
As already mentioned EDP is focusing its growth in hydro capacity as it is going
to be analyzed below in the valuation part In order to conclude if EDPrsquos plan of
future generation mix is optimal we will make an analysis by looking at the
levelized cost of energy (LCoE)36
which can be used to conclude regarding future
investments (figure 34) One could conclude looking at the results in the figure that
coal gas and nuclear are energy sources that EDP should invest into however
one cannot forget that the estimations are very sensitive to pricesrsquo evolution (fuel
inputs) and its components Hence coal is the energy source that it is more
sensitive to CO2 and oil prices followed by gas Consequently the energy source
that will be optimal to use will vary over time However as it is going to be
explained later we do not think that oil prices will decrease more than what they
have already reached as well as CO2 costs will increase In this perspective we
think that in the future EDPrsquos growth target in hydro technology will impact
positively its results
Finally we can see that the liberalized generation segment is still below LT
contracted generation segmentrsquos EBITDA as well in electricity generation (figure
35) however it can also be seen the effect of transference of assets from one
36LCoE give us the average unit costMWh that results in the ration between the PV of the total costs of a generation plant over the PV of the amount of
electricity that is expected to the power plant to generate over its lifetime
Figure 33 ndash Iberian Load Factors of EDP and its Peers (2014) ndash Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
Figure 32 Iberian Installed Capacity (MW) of EDP and its Peers (2013 and
2014) ndash IEnergy Source Percentage
Source Companies Data
0
10
20
30
40
50
60
70
80
90
100
Iberdrola Endesa EDP
2013 2014 2013 2014 2013 2014
Renewables
Cogeneration
CCGT
Coal
Nuclear
Hydro
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 1937
Figure 36 Forecast of Crude Oil prices
Source ldquoCommodity Markets Outlook ndash
World Bank Group ndash January 2015
0
20
40
60
80
100
120
$b
bl
Figure 37 EDPrsquos CCGT energy source
Source Company Data
0
10
20
30
40
50
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
Figure 38 EDPrsquos Coal energy source
Source Company Data
0
10
20
30
40
50
60
0
20
40
60
80
100
120
140
2009 2010 2011 2012 2013
euroM
Wh
Load factor Generation cost
CO2 costs Oil price
segment to the other as the electricity generation and EBITDA is increasing in the
liberalized segment and will continue to increase in the future as will be shown
below
VALUATION
In order to make a valuation of EDPrsquos liberalized generation segment we need to
take into consideration the following key drivers load factors generation costs
(euroMWh) market selling price (euroMWh) future capex (both expansion and
maintenance capex) and operating costs
We will start by estimating generation costs since the results of the load factors will
depend on the hierarchy of the various energy sources Firstly we think that hydro
generation costs will only depend on inflation since this energy source is CO2 free
and does not depend on oil prices We considered the target inflation for the
Eurozone ie 2 Regarding nuclear generation costs we assumed not only that
they will increase with inflation but as well as with an additional penalty in the future
following the Fukushima event in 2011 (as it was already mentioned before) It is
very likely that in the near future the Spanish government intends to include
regulatory requirements for nuclear safety which we estimate to negatively affect
the cost of electricity generated from nuclear sources in 737
Regarding coal and CCGT generation costs we think that the factors that will
influence this energy sources are the CO2 prices and oil costs As EC predicts we
expect carbon prices to rise to euro39tCO238
until 2028 as already mentioned
Regarding oil prices we took into consideration the percentage change in the
forecasts of crude oil average spot ($bbl) (see figure 36) As it can be seen in
figures 37 and 38 with the decrease in CO2 costs and oil prices the coalrsquos
generation costs increased slowly and its load factors also increased By contrast
there was a sharp decrease in CCGTrsquos load factors and sharp increase in its
generation costs As we believe that oil and CO2 costs will increase we believe that
this tendency will reverse hence we expect an increase in the load factors of CCGT
and a decrease in the ones of coal compared from the past
It is also necessary not only to look at the value of this variable for different types of
energy sources but also to analyze new investments from other companies from the
sector As it was already seen the energy source which creates a disadvantage for
EDP is the nuclear energy Although this energy has the highest load factor EDP
currently almost does not produce it which means that if in the future its
competitors increase the use of this type of energy they could create a negative
37Source ldquoSpain Power Report ndash Q2 2015rdquo ndash Business Monitor International Page 23
38ldquoCutting Carbon in Europe ndash The 2020 plans and the future of EU ETSrdquo ndash Carbon Trust ndash page 22
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2037
Table 9 EDPrsquos Hydroelectric structure
Power
plantConstr Start MW
Capex
(euroM)
New hydro power plant
Baixo
Sabor2008 2014 171 6253
Ribeira
dio
Ermida
2010 2014 81 2133
Foz
Tua2011 2016 252 370
Repowering of existing hydro plants
Venda
Nova II2009 2015 746 3225
Salam
onde II2010 2015 207 200
Source info from wwwa-nossa-
energiaedppt
Figure 39 Segmentrsquos evolution
Source Analystrsquos estimates
0
100
200
300
400
500
600
700
800
900
0
5000
10000
15000
20000
25000
30000
EBITDA (euroM) MW
GWh
impact for EDP After analyzing the investment plans of Iberdrola and Endesa for
the following years we have come to the conclusion that neither of this companies
intends to change the current profile of their installed capacity in Iberia Iberdrola
ended the ongoing projects in Spain and will be focusing its future growth in Mexico
namely in the renewable sector Likewise Endesa is now channeling its growth
investments into Latin America
Regarding hydro and nuclear load factors we believe that they will not have a
significant variation in the future In what concerns nuclear energy due its low
generation costs and high priority in the Iberian pool a load factor of 88 similar to
the one which was observed in the past was considered Given the fact that in the
near future there are not relevant climatic changes predicted relatively to the
weather in Iberia for hydro it was considered a load factor of 25 also in line with
what was observed in the past
As already mentioned in the ldquoMacroeconomic Contextrdquo section Spain and Portugal
will experience an increase in its GDP and hence we think that for the Iberia market
selling price increase will be aligned with the target inflation for Eurozone ie 2
The value of capex in the future was determined by taking into consideration the
funds needed to construct new hydro plants plus the repowering and maintenance
needs of older plants EDP recently entered into 5 hydro projects in order to
increase its hydro installed capacity (See table 9)
Taking into consideration information relative to past hydro projects and data taken
from peers we reached an average capex of euro259MW for building new hydro
plants and euro070MW for the repowering of existing ones Additionally we
estimated an average time for concluding the projects of 5 years which results on a
total capex of euro1972 million different from the euro1731 million initially expected by
EDP Since the projects are in its final stage we needed to take into consideration
the money already spent in them which is equal to euro1825 million by 2014 This
means that a residual annual expansion capex of euro74 million is going to be spent in
2015 and 2016 The maintenance capex was calculated by taking into consideration
past costs of installed capacity increases or decreases Additionally in 2018 when
all the assets from the PPACMEC system enter in the liberalized generation
segment we think that EDP will need to make an external maintenance capex in
order to compensate for the seniority of most of the hydroelectric power plants (see
Appendix 3) A hydroelectric power plant can have a useful life between 30 to 75
years39
We assumed that power plants with more than 35 years will be subject to
an extra capex that have the same characteristics of repowering a hydro plant This
means that there is going to exist an annual capex of euro207 million until 2022 From
39EDPrsquos Annual Report
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2137
2022 onwards we estimate that maintenance capex will meet the annual
depreciation
Finally we estimate the operating costs to increase accordingly to the gross profit
except for personnel costs which are going to be dependent on the number of
employees As the gross profit is somehow dependent on the installed capacity the
operating costs are evolving according to the unitrsquos total installed capacity
Valuation 2 ndash Liberalized Iberia Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2028 Total EV 6821
NOPLAT 92 82 13 88 81 73 145 147 372 445 WACC 576
(+) Depreciation 236 236 236 219 231 284 280 291 280 351 g 200
Operating Gross Cash Flow 328 217 249 307 312 357 425 438 652 797 OpValue 1746
(-) Capex -488 -502 -508 -1055 -214 -460 -112 -1649 -396
New hydro and repowering -412 -442 -485 -503 -74 -74 0 0 0
Transference -37 0 0 -526 -111 -354 -80 -1397 0
Maintenance -39 -60 -23 -25 -29 -32 -32 -251 -396
(-) Change in NWC -202 162 -1 -83 -19 -61 -8 -194 -10
Operating Free Cash Flow -373 -91 -202 -825 124 -96 318 -1191 391
ELECTRICITY SUPPLY IN IBERIA
EDPrsquos segment related with the supply of electricity is divided in two different sub-
-segments last resource supply (LRS) which is regulated and liberalized supply
These operations are made both in Portugal and Spain Figures 40 and 41 show
the market share of the most important electricity supplying companies in Spain
and Portugal respectively As it can be seen in Spain EDP has the fifth largest
market share and in Portugal it is the market leader followed by Endesa and
Iberdrola
In figure 42 it is possible to observe that out of the top 4 Iberian electricity
supplying companies EDP is the one in which the value of electricity supplied
under the regulated regime is higher when compared to the value of electricity
supplied to the liberalized market This can be seen as a direct result of the fact
that in Portugal the liberalization process is in an earlier stage when compared to
Spain However the supply of energy under the LRS regime will not continue after
the end of 2015 which means that in the near future the value of electricity
supplied under this regime will become residual
The fact that the liberalization process is in a different stage in Portugal and Spain
is accurately illustrated by figure 43
Figure 42 Iberian supply of electricity (liberalized vs regulated) amongEDP and its competitors - 2013
Source EDP
0 10 20 30 40
Endesa
Iberdrola
EDP
Gas Natural Fenosa
Other Electricity Free Retail
Electricity RegulatedRetail
Figure 41 Market share of electricitysupply ndash Portugal ndash 2014
Source ERSE
EDPCom46
Endesa
19
Iberdrola
16
Others12
Galp7
Figure 40 Market share of electricitysupply ndash Spain - 2014
Source CEER
Endesa32
Iberdrola
20
Others20
GNF17
EDP8
EON3
Figure 43 Market Share of electricity supply
Source EDP
0
20
40
60
80
2009 2010 2011 2012 2013 2014
PT SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2237
Figure 44 Behavior of electricity sold and of
nordm of clients ndash Portugal
Source EDP
0
500
1000
1500
2000
2500
3000
3500
0
5000
10000
15000
20000
20092010 201120122013 2014
Volume sold (GWh) Clients (th)
Figure 45 Behavior of electricity sold and of
nordm of clients ndash Spain
Source EDP
0
200
400
600
800
1000
0
5000
10000
15000
20000
25000
200920102011201220132014
Volume sold (GWh) Clients (th)
Figure 46 Behavior of electricity consumptionwith GDP growth
Source GDP growth (by IMF) Consumptiongrowth(by ldquoSpain Power Report Q2 2015 ndash BMI
-2
-1
-1
0
1
1
2
-200
-100
000
100
200
300
Consumption Net Consumption y-o-y (Electricity)
GDP growth
As it can be observed the market share of EDP in Spain has been fairly stable in
this country for the past 5 years due to the fact that the market is already mature
In contrast in 2010 and 2011 EDPrsquos Portuguese market share suffered a
significant decrease which was caused by the acceleration of the liberalization
process In this country as costumers started to make their transition from the
regulated market to the liberalized one they became much more sensitive to the
price and in many cases opted to change their supplier of electricity
It is interesting to note that the evolution of the number of clients in Spain and
Portugal follows a very similar behavior exhibited by the evolution of volume sold
By observing figures 44 and 45 which shows the evolution of these variables in
the liberalized market it is possible to conclude once again that the supply of
electricity under this regime is considerable more mature in the Spain (less
volatility)
VALUATION
In order to perform the valuation of this segment the following key drivers were
taken into account market share electricity demand growth Gross ProfitMWh
and capex
Regarding the market share electricity supply in Spain has an historic market
share which is close to 10 As it has already been seen the segment in this
country can be considered mature which means that in the future there will not
exist relevant changes on this variable For Portugal although the market share of
EDP has decreased significantly since 2009 we believe that there has been
stabilization around 44 in the past two years which will be maintained in the
future as most of the costumers which wanted to change from EDP to other
operators probably have already done so between 2010 and 2012 (see figure 44)
Concerning electricity demand for the future we can see in figure 46 that the
estimates made for this variable are positively correlated with the GDP growth In
this sense to determine the Portuguese demand for electricity in the future we use
the estimates of GDP growth published by IMF for this country (Appendix 2) We
used these estimates for Portugal due to the fact that it was not possible to find
reliable estimates of electricity demand growth in the future Regarding Spain the
future demand for electricity was taken from a report published by Business
Monitor which analyzes the future electricity consumption in this country
As it has already been mentioned in the future the supply of electricity will be
performed exclusively in the liberalized market where there is price competition
In this sense we think that gross margins as percentage of MWh will be fairly
constant in the future as operators will not have enough bargaining power with
the costumers to increase prices To forecast the gross margins all that was done
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2337
RoRAB=
WACC(pre-tax)
CPI measured by
inflation
Efficiency factor set
by regulators
Updated each year by aprice cap mechanism
(CPI ndash X)
Allowed Return Controllable costs
Regulated Revenues
Depreciation + OPEXRAB x RoRAB
was to update them to inflation for the future years The gross margins observed
in past periods have been regular and situated around euro12MWh in Portugal and
euro6MWh in Spain
Regarding the Capex we do not expect major investments since this is not a
capital intensive segment and its investments are essentially allocated to devices
used to measure electricity We expect this variable to be represented only by
maintenance capex As it can be seen by the result yielded by the valuation this
segment is the one which has the lowest contribution to EDPrsquos overall value
Valuation 3 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 174
NOPLAT 28 - 22 17 2 13 19 14 14 14 13 WACC 576
(+) Depreciation 0 0 1 1 1 2 3 4 5 6 g 200
Operating Gross Cash Flow 29 - 22 18 2 14 22 17 18 19 20 OpValue 045
(-) Capex 0 -6 -1 -10 -12 -12 -13 -13 -13
(-) Change in NWC 55 -59 -4 74 0 7 7 0 0
Operating Free Cash Flow 33 - 48 - 3 78 9 13 13 6 6
Valuation 4 ndash Electricity Supply PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 376
NOPLAT 13 - 4 25 4 15 16 16 16 16 16 WACC 574
(+) Depreciation 1 1 1 1 0 1 1 2 2 2 g 200
Operating Gross Cash Flow 15 - 3 26 4 15 17 17 17 18 19 OpValue 096
(-) Capex 2 5 0 -5 -5 -4 -4 -3 -3
(-) Change in NWC 36 -113 -3 27 -7 -2 -1 -4 -1
Operating Free Cash Flow 35 - 82 2 38 5 11 13 12 15
ELECTRICITY DISTRIBUTION IN IBERIA
This segment is responsible for the distribution of electricity under the regulated
market in Portugal and Spain and its impact on EBITDA in 2014 was 19 and 3
respectively In Portugal EDPD40
owns approximately 99 of the electricity
distribution network in the mainland (223523 Km in 2014) and is regulated by
ERSE41
In Spain HC Energiacutea42
owns a network of 23395 Km (data for 2014)
and distributes electricity mainly to Asturias and to a lower length also to Madrid
Valencia Alicante Huesca Zaragoza and Barcelona The regulation of electricity
distribution in this country is performed by CNE43
The remuneration of EDPrsquos distributing activities is dependent on two relevant
factors (see figure 47) The return on the regulatory asset base (RoRAB) is
established by ERSE and CNE and is applied in the assets that EDP employs to
distribute electricity (RAB) The return is established for periods of three years for
Portugal and four years for Spain The most recent regulatory period starts in
2015 and is going to end on 2017 for Portugal and in Spain we are in the middle of
the regulatory period 2013-2016
40EDPD ndash EDP Distribuiccedilatildeo is responsible for electricity distribution in Portugal
41ERSE is responsible for defining the tariffs parameters and prices of electricity while at the same time safeguarding the levels of quality and service
required by DGGE - Direcccedilatildeo Geral de Geoglogia e Energia42
HC Energiacutea is the responsible for the distribution of electricity in the regulated and unregulated market in Spain43
CNE as in the case of ERSE is also responsible for defining the main parameters that rule the distribution activities but in this case for Spain
Figure 47 RAB-based regulatory formula
Source EY Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2437
Figure 48 EDPrsquos controllable operating
costs ndash Electricity Distribution
Source Company Date
4335 4335416
389
1385 136 131 124
0
50
100
150
200
250
300
350
400
2011 2012 2013 2014
euroM
PT SP
Figure 49 Evolution of OPEX
Source ERSE EDPD
340
350
360
370
380
390
400
410
420
430
440
2012 2013 2014
euroM
OPEX controlaacutevel real
OPEX controlaacutevel ERSE
Figure 50 Evolution in Portugal
Source Company Data
41000
42000
43000
44000
45000
46000
47000
48000
49000
6020
6040
6060
6080
6100
6120
6140
6160
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
Figure 51 Evolution in Spain
Source Company Data
635
640
645
650
655
660
665
0
5000
10000
15000
20000
25000
2009 2010 2011 2012 2013 2014
GW
h
Th
ou
san
ds
Clients Electr Distrib
As can be seen in figure 48 OPEX has been decreasing following the necessity
of both countries to decrease its countryrsquos tariff deficit meaning that they are also
improving in terms of efficiency and productivity In Portugal the company was
able to increase the ratio of electricity distributed per employee (MWh) from
12858 in 2011 to 13144 in 2014 In Spain the same increase was seen (29555
in 2011 to 31214 in 2014) In order to cut the controlled costs of electricity
distribution companies all that the regulator has to do is to define an efficient
factor higher than the CPI Effectively EDPD has been able to reach OPEX very
similar to the ones of published by ERSE (figure 49)
Regarding the growth in the electricity distribution segment we can conclude that
it already reached a significant degree of maturity and as such the customer base
has been somehow stabilizing in the past years and the decrease in the past
years is due to the weak macroeconomic context as can be seen below
Besides the regulated profit EDP has non-regulated operations in this segment
however they represent 1 and 4 of this segment for Portugal and Spain
respectively (table 10)
VALUATION
Although in the previous regulatory period (from 2012 to 2014) the RoRAB for
Portugal was indexed to the 5-year Portuguese CDS so that the disruptions in the
10-year Portuguese bonds caused by the financial crisis could be avoided for the
current regulatory period this is no longer valid The final RoRAB for the new
regulatory period results from a daily average of the 10 year bond yields44
of
Portugal The value of the RoRAB defined is 675 for Portugal Comparing the
RoRAB after tax with our WACC the following differences can be observed (table
44For the year 2015 for example the average is computed between October of 2013 and September of 2014 with a minimum floor at 6 and a maximum
cap at 95
Table 10 ndash Electricity RegulatedGross Profit ndash 2014 (euroM)
PT SP
Regulated 1278 156
Non-regulated 8 7
Total 1286 163
Source Company Data
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2537
Table 11 Comparison of the ERSE and
Analystrsquos WACC
ERSE Analyst
Difference
t 3150 2950 -6
DD+E) 55 46 -16
Beta ofCP
093 091 -2
Re (aftertax)
629 632 0
Rf 214 229 7
Defaultspread
2 371 86
PD - 038 -
RR - 6220 -
Rd(beforetax)
441 614 39
Rd (aftertax)
302 413 43
WACCafter tax
449 541 20
WACbeforetax
675
Source ERSE and Analystrsquos estimates
11) The major difference between WACCs is in the cost of debt The default
spread assumed for ERSE was an estimation made by Damodaran that takes into
account a theoretical gearing of 55 however we used the average of the past 4
years of EDPrsquos CDS (the same methodology used in the previous regulatory
period) Additionally we considered the effect of probability of default In this
sense we reached a higher WACC after tax compared with the regulator
However as the remuneration rate defined is before tax the RoRAB is higher
than our cost of capital Hence this will lead a fair value of the segment higher
compared to the RAB Despite we do not have consider this hypothesis we think
that ERSE should re-think the way it defines the RoRAB and should apply a
WACC after tax in order to be in accordance with the cost of capital
In Spain the RoRAB is going to be dependent on the 10-year Spanish bond yields
plus a 200 basis point premium which is going to be added between 2014 and
2020 The sum of these two factors is going to yield a value equal to 6545
The estimated RAB for Spain for the period 2013-2016 corresponds to euro830
million46
For Portugal the estimated RAB is euro3013 million and can be consulted
on ERSErsquos report47
As can be seen in the valuation provided below the fair value
is higher than the RAB for both Portugal and Spain
The efficient factor that is going to be applied to Portugal distribution is going to be
equal to 35 in 2015 and 25 in 2016 and 2017 Given the fact that in a report48
published this year by ERSE related with the efficient factor which should be
applied to the electrical energy suppliers it is stated that EDPD has been
increasingly registering costs which are converging to the costs accepted by the
regulator Hence we believe that in the future the efficient factor will decrease to
1 For Spain it was considered an efficient factor of 149
taking into
consideration the information published by CNE The CPI used for the period in
analysis can be seen in the estimates published by the IMF (see Appendix 2)
Since the operations of electricity distribution can be considered a very mature
business there does not exist a major need for investments which means that the
defined Capex is going to be equal to depreciation
45Tthe RoRAB for the previous regulatory period was equal to 8
46We considered as a proxy to RAB the net fixed assets as CNE does not disclose this information
47ldquoProveitos Permitidos e ajustamentos para 2015 das empresas reguladas do sector eleacutetricordquo ndash Dezembro 2014 - ERSE
48ldquoParecer sobre ldquoProposta de Tarifas e Preccedilos para a Energia Eleacutetrica e Outros Serviccedilos em 20 paracircmetros para o periacuteodo de regulaccedilatildeo 2015-2017rdquo -
ERSE49
ldquoInforme 242013 de la CNE sobre la Propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribuicioacuten de la actividad
de distrbuicioacuten de energiacutea eleacutectricardquo - CNE
Figure 52 RoRAB around Europe ndashElectricity -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10
Germany()
Poland()
Finland()
CzechRepublic()
France()
Slovakia()
Average
Portugal()
Spain()
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2637
Figure 53 EDPrsquos coverage in the distribution
segment in Portugal and Spain
Source EDP
Valuation 5 ndash Electricity Distribution PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 5227
NOPLAT 238 308 315 291 302 236 186 182 187 182 WACC 541
(+) Depreciation 248 243 234 234 255 253 253 254 253 253 g 200
Operating Gross Cash Flow 486 551 549 525 557 489 439 436 441 436 OpValue 1328
(-) Capex -185 -255 -419 -255 -253 -253 -254 -253 -253
(-) Change in NWC -524 -637 -298 24 14 37 4 -2 5
Operating Free Cash Flow - 158 - 344 - 192 326 250 223 186 185 187
Valuation 6 ndash Electricity Distribution SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 1416
NOPLAT 71 106 69 58 50 49 50 51 51 51 WACC 539
(+) Depreciation 34 31 32 34 35 37 37 37 37 37 g 200
Operating Gross Cash Flow 105 136 101 92 85 87 88 88 88 88 OpValue 362
(-) Capex -117 -68 -93 -35 -37 -37 -37 -37 -37
(-) Change in NWC 21 35 3 -22 0 0 0 0 0
Operating Free Cash Flow 41 68 2 28 50 50 51 51 51
GAS IN IBERIA
The operations of EDP related with gas in Iberia are divided between distribution
which is a completely regulated activity and supply which encompasses regulated
(LRS) and liberalized activities EDP has a relevant presence in the gas sector
through Naturgas in Spain (2nd
largest gas distributor in this country) and through
EDP Gas in Portugal (2nd
largest natural gas distributor in this country)
The remuneration scheme of this segment has a framework that is very similar to
the one which exists in the electricity distribution in which the parameters are
established by ERSE in Portugal and CNE in Spain Due to the high tariff deficit
that for the past years has existed in the Spanish gas sector in 2014 CNE
decided to change the remuneration for the regulated activities50
In Portugal
ERSE published the new regulations for the regulatory period starting in 2013 and
ending in 2016 on June of 2013 Both regulators decided to define a RoRAB for
the current regulatory period equal to 9
In terms of market share it is possible to observe in figure 54 that Gas Natural
Fenosa (which has a core business completely tied to gas) is the market leader in
Iberia followed by Galp EDP Endesa and Iberdrola
Regarding the evolution of EDPrsquos market share in the gas sector both in Portugal
and Spain after observing (figure 55) we can conclude that during the most recent
years it has been stabilizing in both countries This fairly stable behavior for both
Portugal and Spain allied to the fact that the market is now mature has led us to
conclude that EDP is close to reach market share equilibrium in this segment
50The inflation update factor is eliminated from the remuneration allowed revenues are cut and returns are more dependent on demand
Figure 54 Iberian Share of Conventional
Natural Gas Retail (TWh) - 2013
Source Company Data
15 4
7
45
12
17
EndesaIberdrolaEDPGas Natural FenosaGalpOthers
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2737
Figure 57 Demand evolution for Natural Gas inPortugal
Source PDIRGN 2014-2023 ndash REN ndash Maior2013
0
10
20
30
40
50
60
Figure 56 RoRAB around Europe -Gas -2012
() Nominal rate () Real rateSource EY search ERSE CNE
0 5 10 15
Germany()
Poland()
Finland()
Czechhellip
France()
Slovakia
Greece
Switzerland
Average
Portugal()
Spain()
Figure 58 EDPrsquos Distribution of Gas ndashGross Profit
Source Company Data Analystrsquos estimates
0
50
100
150
200
250
2013 2014 2015 2016 2017 2018 2019
PT SP
VALUATION
The key drivers of the segment tied to distribution of gas are the RoRAB RAB
capex and efficient factor Based on the explanations already provided above the
future RoRAB estimated for the operations in Iberia is equal to 9 We estimated
the future RAB for Spain to be the value of the fix assets of the company51
responsible for the gas distribution in this country which is euro1012 million
Regarding Portugal it was assumed that the RAB for the valuation period would
be equal to the one published by ERSE for 2015 which is $44552
million Once
again as the RoRAB is higher than our WACC this will lead to a fair value higher
than the RABs presented above
The efficiency factor for the operations in Spain was set to 153
for the period that
is being valued The efficient factor applied for the distribution of gas in Portugal is
1554
As it was already stated above since this is a mature segment we donrsquot
believe that major investments will occur which means that the future estimated
capex are equal to depreciation
The key drivers which are necessary to value the supply segment are the market
share growth in gas demand gross profitGWh and capex Regarding the market
share we believe that it will remain stable in the future due to the fact that the gas
supply in Iberia is now a mature market in which EDPrsquos market share has been
stabilizing in the past few years as it has been mentioned above
In order to estimate the volume of gas sold in the future for Portugal and Spain it
was necessary to take into consideration the future growth in demand For
Portugal it was assumed that the estimates published by REN (figure 57) which
forecast an annual growth of approximately 2 are accurate For Spain it was
assumed that the growth in demand is going to be equal to the GDP growth
estimated by IMF (see Appendix 2) It was already seen in the electricity supply
segment that energy demand is positively correlated with the country growth
51Naturgas Distribuicioacuten
52ldquoProveitos permitidos e ajustamentos para o ano gaacutes 2014-2015 das empresas reguladas do setor do gaacutes naturalrdquo June 2014 ERSE
53ldquoInforme 242013 de la CNE sobre la propuesta de real decreto por el que se establece la metodologiacutea para el caacutelculo de la retribucioacuten de la actividad de
distribucioacuten de energiacutea eleacutectricardquo September 12 2013 CNE (page 24)54
ldquoParacircmetros de regulaccedilatildeo para o periacuteodo dos anos gaacutes de 2013-2014 a 2015 -2016rdquo June 2013 ERSE
Figure 55 Behavior of EDPrsquos market share in the free market - Gas
Source Company Data
0
10
20
30
2008 2009 2010 2011 2012 2013 2014
PT
SP
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2837
Figure 61 ndash Brazilian Installed Capacity at
2014
SourceldquoBrazil Power Report Q2 2015 ndash BMI
20 1
66
13Coal
Nuclear
Hydro
Non-hydroRenewables
Figure 59 EDPrsquos Supply of Gas ndash GrossProfit
Source Company Data Analystrsquos estimates
-
50
100
2013201420152016201720182019
PT SP
(measure by GDP growth) Regarding gross profitGWh we think that the fact that
the segment is already mature will lead to stability in this variable The only action
taken to forecast it was to update it to account for future inflation
As it happened in the electricity supply segment since this is a not a capital
intensive segment the Capex will be in line with previous years
Valuation 7 ndash Gas PT Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 818
NOPLAT 17 30 28 18 22 20 21 21 22 22 WACC 541
(+) Depreciation 30 24 25 25 27 26 25 24 24 23 g 200
Operating Gross Cash Flow 47 54 53 43 49 46 46 45 46 45 OpValue 209
(-) Capex -46 -34 -35 -15 -16 -16 -16 -16 -16
(-) Change in NWC -8 35 1 -11 -2 0 0 -1 0
Operating Free Cash Flow - 0 54 8 22 28 30 29 29 30
Valuation 8 ndash Gas SP Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 2905
NOPLAT 99 120 109 113 79 87 87 88 89 89 WACC 539
(+) Depreciation 87 76 74 78 82 80 78 77 76 74 g 200
Operating Gross Cash Flow 186 195 184 192 161 167 165 165 164 163 OpValue 744
(-) Capex -196 -61 -151 -59 -60 -61 -61 -59 -59
(-) Change in NWC -39 31 -6 -3 3 0 -1 -1 0
Operating Free Cash Flow - 40 154 35 99 109 105 104 105 104
BRAZILIAN OPERATIONS
This segment represented in 2014 17 of the overall EBITDA Within Brazil the
distribution segment represented 48 of the EDPBrsquos EBITDA while the
generation represented 47 and supply represented 5 In Brazil the
consumption55
of electricity is made through the regulated market and the
liberalized one
GENERATION AND SUPPLY
The electricity generation segment in Brazil is mostly characterized by the
existence of PPAs between generators and distributors and by the intensive use
of hydroelectric sources of power (figure 61)
In this country the generators can participate in a mechanism called MRE56
in
order to assure the compliance of CG ndash figure 62 In order to measure if the total
generation of MRE participants is not below the sum of contracted generation it is
used a variable named generation scaling factor GSF57
If GSF is below 100
55The costumers with consumption lower than 3 MW on average (which normally are residential commercial and industrial consumers) are supplied by
distribution companies (which belong to the regulated market) The consumers with annual demand above 3 MW are supplied by the free market whichrepresents 28 of the electricity sold in Brazil56
MRE ndash Mecanismo de Realocaccedilatildeo de Energia RP ndash real produtcion CG ndash Contracted Generation57
Geraccedilatildeo Hidraacuteulica GWhmGarantia Fiacutesica GWhm
Volume thatgenerators must
supply at the nationalsystem (SIN)
Inflationupdatedevery year
Selling price
PPAaverage life of 15 years
Beginning of the contract is defined
Contracted Generation
Figure 60 Brazilian Generation System
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 2937
Figure 63 Behaviour of PDL with GSF
Source Montly MRE Reports for GSF data and CCE for PLD data
000
020
040
060
080
100
120
140
-50
50
150
250
350
450
550
650
jan
-10
ab
r-10
jul-
10
ou
t-10
jan
-11
ab
r-11
jul-
11
ou
t-11
jan
-12
ab
r-12
jul-
12
ou
t-12
jan
-13
ab
r-13
jul-
13
ou
t-13
jan
-14
ab
r-14
jul-
14
ou
t-14
Perc
en
tag
e(
)
R$M
Wh
PLD GSF
Figure 64 Installed capacity mix of the 4th
largest private Brazilian generators
Source Each company data
0
20
40
60
80
100
120
Tractebel- Brazil
AESTietecirc
CPFLEnergia
EDPBrasil
Hydro
Thermal
Non-hydro renewables
Cogeneration
Thermal (Biomass)
than the participants become exposed to the spot market - PLD58
because they
have to buy electricity from more expensive fossil-fuelled generators The recent
volatility in the energy purchase price at the spot market results from unfavorable
hydrological issues The recent low production is the result of a huge drought
which is already being considered the worst in 8 decades and that is leading the
PDL to reach abnormal values as it can be seen below
Given the recent PLD high surges ANEEL recently approved new rules to
manage energy prices in the spot markets defining a minimum price of
R$3026MWh and a ceiling of R$38848MWh
In Brazil EDPB is the 4th
largest private operator in generating electricity and is
present in 10 states By observing figure 64 it is possible to conclude that EDPB
follows the pattern of the Brazilian generating segment having most of its installed
capacity concentrated in hydro sources of power
Additionally the company is currently constructing 3 new hydro plants (table 12)
that are going to start its operations between 2015 and 2018 Besides the
investment in hydro plants EDPB has a 50 share of the coal plant located in
Peceacutem with a proportional installed capacity of 360MW
Regarding Brazilian load factors (figure 65) we can conclude that once again the
energy source that provides the higher load factor is the one produced in nuclear
power plants However despite this high load factor we think that Brazil will not
expand its installed capacity in this source mainly due to the accident that
happened at Fukushima in 2011 This accident has led the Brazilian officials to
change59
the plan to increase the countryrsquos nuclear power base
Enertrade is the company responsible for the supply of energy and rendering of
services to the liberalized market The volume supplied has been oscillating along
the years (figure 66)
58The level of exposure of generators to the spot market is reflected by the PLD (Preccedilo Liacutequido das Diferenccedilas) which measures the cost of differences
between generated and contracted energy which have to be settled in the spot market59
In May 2012 the Ministry of Energy announced that increasing the number of nuclear power plants is not part of the 10-year energy plan (2012-2022)being Angra II the only nuclear power station planned to be built during the period in question
Measured by
Then
This only happens if
If
TOTAL RP of MREs participants gt TOTALCG of MREs participants
MREAll generators can participate
RP of some participants lt Its CGAnd
There are participants with RP gt Its CG
Transference of electricity surpluses forthose which CGltRP
GSF=TOTAL RP of MREsparticipantsTOTAL CG of MREs
participants
Figure 62
Source Nova Equity Research
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3037
Table 12 Hydroelectric in EDPB
Power plantsProportional
InstalledCapacity (MW)
In operation
Lajeado 903
Peixe Angical 499
Energest 396
Peceacutem 360
In construction
Jari 1865
Cachoeira-Caldeiratildeo 1095
Satildeo Manoel 231
Source EDPB
Figure 65 Brazilian Load Factors ndash energy
source ()
Source ldquoBrazil Power Report Q2 2015 ndash BMI
79
89
49
36
Coal
Nuclear
Hydro
Non-hydroRenewables
0 50 100
Figure 67 Contracted Generation (GWh)
Source EDPB data
0
10000
2010 2011 2012 2013 2014
GW
h
EnergestPeixe AngicalLajeado
Figure 66 Gwh Supply - Enertrade
Source EDPB
0
5000
10000
15000
20000
25000
30000
VALUATION
In order to determinate the value of the generation segment in Brazil we gave
special attention to the following factors selling price of electricity PLD prices
generation costs real production of plants contracted generation generating
scaling factor (GSF) capex and inflation
As regards to the PPAs we took into consideration the selling prices of the
hydroelectric plants already in operation at 2014 and the selling price for the coal
plant in Peceacutem For the new hydroelectric plants we took into consideration the
already published selling prices To determine the future selling prices we updated
the current prices by using the data published by IMF regarding the inflation rate for
Brazil (see Appendix 2)
Regarding the contracted generation volume in the future we used the same values
observed in 2014 for the existing hydroelectric plants If we look for the contracted
generation of the past few years it is possible to see that the values are fairly stable
(figure 67) Concerning the contracted generation volume for the coal plant and for
the new hydro plants we also took in consideration the already contracted
generation The summary of the data above can be viewed below
Table 13 ndash Hydroelectric Data ndash EDPB
Legend
() selling price and contracted generation in 2014
() selling price according to the date of commence activities (Peceacutem - 2015 Jari - 2015 Cachoeira-Caldeiratildeo - 2017
Satildeo Manoel - 2018) The contracted generation was the one assumed at the beginning of the contract)
() data from 2013 For the new hydro plants we considered the average of the already existing ones
Source company data
Regarding generation costs as it was already mentioned in instances where the
GSF is below 100 besides the costs of producing the energy the generators also
have to incur on a cost to buy the contracted generation deficit in the spot markets
Given the fact that in the present moment the GSF is lower than 100 in order to
isolate this effect from the cost of producing electricity it was necessary to use as
reference the data from 2013 which was the last year in which the GSF was higher
than 100 (104) meaning that the generators did not have to purchase energy at
SellingPrice
(R$MWh)
ContractedGeneration
(MWh)
Costs with producigelectricity - R$ mnMWh
()
Lajeado () 142 3298000 16
Peixe Angical () 198 2375250 30
Energest () 165 2538688 49
Peceacutem I () 191 2693700 137
Jari () 115 1664400 32
Cachoeira-Caldeiratildeo () 95 1136172 32
Satildeo Manoel () 83 3591600 32
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3137
spot markets to meet their PPA obligations Fundamentally in this year the
generation costs were only caused by the production of electricity (table 13) For the
future we assumed that hydro costs will increase with Brazilian inflation and for the
coal plant as in the Iberian generation we estimate its costs according to the future
forecast of the oil prices We also need to consider if the GSF will be below or
above 100 in the future As stated above Brazil is facing a huge drought and we
think that this is an abnormal situation Hence we think that the rainfall will
normalize in the future In order to estimate the GSF we took in consideration the
last GSF (2014) and since we believe that the generation will increase we used
estimations from BMI In that sense we computed the future GSF according to the
increase of the future electricity generation in Brazil
As it can be seen (figure 68) there are years where the GSF is below 100 In
those cases we used the average of the future PLD (average between the defined
minimum and ceiling stated above) which is R$209MWh and added it to the
generation cost of the hydroelectric plants to account for the fact that they have to
buy electricity in the sport markets
Regarding capex as it was already mentioned EDPB is currently constructing 3
hydro plants which will lead to an increase of the installed capacity from 2158 MW
in 2014 to 2685 MW in 2018 After making a search to determine the cost of
building these hydroelectric plants we concluded that there does not exist any
evidence which shows that the estimated capex by EDPB for the new plants is not
correct Taking into consideration the investment already made we estimated the
remainder expansion capex as can be seen below For the maintenance capex we
took into consideration past costs and updated them according to the installed
capacity
In order to understand the level of variation of the demand for electricity in Brazil
various forecasts were consulted Most of these forecasts clearly point to an
Figure 68 Forecast for future GSF ndash EDPB Operations
Source Analystrsquos Estimates
080
085
090
095
100
105
110
480000
500000
520000
540000
560000
580000
600000
620000
640000
2014 2015 2016 2017 2018 2019P
erc
en
tag
e(
)
TW
h
Electricity Generation GSF
Figure 69 Consumption of Electricity in
Brazil (TWh)
CAGR 463 CAGR406
Source ldquoPlano Decenal de Expansatildeo de
Energia 2023rdquo by Empresa de Pesquisa
Energeacuteticardquo
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3237
RoRAB
=
WACC
(post-tax)
Non-Controllable
Costs
Regulated Revenues
RoRAB xRAB
PART A PART B
ControllableCosts
Updated eachyear by price-cap
mechanism(IGP-M ndash X
Factor)
Figure 71 Evolution of EDPBrsquos Distribution
segment
Source EDPB
2500
2600
2700
2800
2900
3000
3100
3200
82000
83000
84000
85000
86000
87000
88000
89000
90000
Th
ou
san
ds
KM
Network Clients
increase in this demand Taking into account the estimates from ldquoPlano Decenal de
Expansatildeo de Energia 2023rdquo (PDE 2023) we estimated that the gross profit of the
supply segment will increase by 46 (see figure 69)
Valuation 9 ndash Brazilian Operations - Generation and Supply Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 6210
NOPLAT 171 194 171 163 122 250 251 264 292 284 WACC 779
(+) Depreciation 66 70 63 75 52 40 43 46 47 48 g 475
Operating Gross Cash Flow 237 264 234 237 175 290 294 310 339 332 OpValue 1589
(-) Capex -451 397 328 -17 -213 -205 -144 -141 -112
(-) Change in NWC 51 47 -112 9 -33 3 3 3 2
Operating Free Cash Flow - 137 678 453 167 44 92 169 201 222
DISTRIBUTION
The distribution companies which operate in this country do it through concession
areas where they are the sole supplier In the case of EDPB its distribution
operations are performed by EDP Bandeirante which serves 28 municipalities of
Satildeo Paulo and EDP Escelsa that covers 78 municipalities in Espiacuterito Santo The
parameters for each concession are defined by ANEEL60
(RAB X Factor61
RoRAB etc)
This is a growing segment in EDP with an average increase of 3 in the clientsrsquo
base in the last years due to its increase in network The electricity distributed has
been increasing approximately at the same rate (figure 71 and 72)
VALUATION
The key value drivers for this segment are the RAB RoRAB controllable and non-
controllable costs and capex We considered the RoRAB to be 80962
ANEEL defines the RAB independently for each concession For EDP Bandeirante
the defined RAB is equal to R$ 1545 million (regulatory period 2012-2015) and for
EDP Escelsa the defined RAB is equal to R$ 1566 million (regulated period 2013-
2016) In order to estimate the RAB for the next regulatory periods we took into
consideration the investments that will be made to increase the network As stated
in PDE63
2023 it is expected that the size of transmission lines in Brazil (measured
in Km) will increase from 112660 km in 2013 to 182477 km in 2023 In this sense
in the next regulatory period of each concession we will consider the increase in the
network and account it in the RAB
In order to estimate the controllable costs we took into consideration the
controllable costs from 2014 (R$593 million) and updated them for the future taking
into consideration the future inflation of Brazil (estimated by IMF) and the X factor
60ANEEL is the Brazilian National Electric Energy Agency responsible for the regulated segment in Brazil
61The x factor estimates potential productivity gains based on energy consumption and market expansion It also reflects the quality of services and the
level of operating expenditures in order to encourage a higher efficiency62
In February 2015 ANEEL proposed a post-tax WACC of 809 to be applied to the distribution of electricity in the upcoming 4th revision cycle63
Plano Decenal de Expansatildeo de Energia 2023rdquo by Empresa de Pesquisa Energeacuteticardquo - Brazil
Figure 70 Regulated revenues in Brazil
Source ANEEL
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3337
Figure 73 Distribution of Installed
Capacity between the energy sources
(2014)
Source EDPR
Wind
Solar
Figure 74 Comparison of EDPRrsquos load
factors with market - by region (2014)
Source EDPR
0
5
10
15
20
25
30
EDPRMarket
Figure 72 Evolution of EDPBrsquos Distribution
segment
Source EDPB
-300
200
700
1200
1700
21500
22500
23500
24500
25500
26500
R$
M
GW
h
Electricity Distributed
Gross Profit
Regarding the X factor we used the average of the X factor estimated for
Bandeirante and Escelsa which is 044 and 233 respectively Regarding
the non-controllable costs we estimated them taking into consideration the cost
per Km which is around 7 R$Km Taking into consideration future investments
in the network we updated the R$Km for the future using the inflation
Regarding the KMrsquos increase we estimated them according to the forecasts
published by EPE64
Once again our WACC is below the remuneration rate leading to the same
conclusion in the Iberian distribution segment
Valuation 10 ndash Brazilian Operations - Distribution Analystrsquos estimates
Millions of Euros 2010 2011 2012 2013 2014 2015E 2016E 2017E 2018E 2019E Total EV 3881
NOPLAT 193 156 99 123 130 138 143 153 159 162 WACC 779
(+) Depreciation 84 107 85 104 98 94 92 90 89 89 g 475
Operating Gross Cash Flow 277 264 184 227 228 232 235 243 249 251 OpValue 993
(-) Capex -147 -135 -129 -113 -104 -107 -110 -112 -115
(-) Change in NWC 13 21 113 83 -103 -1 0 5 -1
Operating Free Cash Flow 129 70 211 198 25 127 133 141 135
NON-HYDRO RENEWABLES SECTOR
EDPR is the company responsible for energy generation through the use of wind
farms and solar plants representing 25 of EDPrsquos EBITDA (2014) It is
considered one of the largest producers of electricity generated by wind energy in
the world and it owns turbines with load factors and profit margins which are
higher than the average comparable equipment operated by other companies in
the same the industry (figure 74) Between 2008 and 2014 this company
experienced a very significant growth having doubled its installed capacity from 4
GW to 8 GW EDPR is present in various countries located in Europe and also in
the United States of America and Brazil (figure 75) The fact that this subsidiary is
present in various countries which have different currencies increases the overall
currency risk of the segment
Since last year EDPR has been affected by negative effects caused by
unfavourable changes in the regulation of its activities in Spain and also by low
market prices offered to acquire the energy that it produces In order to minimize
these effects the subsidiary has devised a plan which will lower its exposure to
European wholesale prices and regulation by shifting a great chunk of its future
growth into the US (see figure 76)
64EPE - Empresa de Pesquisa Energeacutetica
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3437
Figure 75 EDPRrsquos market share in the different
regions - 2014
Source EDPR
0
5
10
15
20
25
30
Ca
na
da
Port
ug
al
Spa
in
Ro
ma
nia
Pola
nd
US
A
Fra
nce
Belg
ium
Ita
ly
Bra
zil
As it has been mentioned in section dedicated to the valuation methods used in
this report since we do believe that the market value of EDPR reflects its true
value The companyrsquos market capitalization at the date of 29-05-2015 was
euro5716235 million (euro655 each share)
FINAL CONCLUSIONS
SUM-OF-THE-PARTS
We give a Hold rating and a Price Target of euro354 per share to EDP This
represents a 1 downside from the market price but due to the high dividend
yield the shareholder return is positive in 6 As it can be seen below the major
drivers for our target price are the Iberian liberalized segments EDPB and EDPR
due to the positive prospects expected from the increase in the installed capacity
of these segments The regulated business has the lowest impact due to the
measures that have been made in Iberia to reduce the tariff deficit
SENSITIVE ANALYSIS
In order to understand the impact that changing some inputs can have in the final
target price we performed a sensitive analysis in the inputs that can influence the
most the EDPrsquos value ie perpetuity growth exchange rate weather regulation
and countryrsquos financial situation The results can be seen in Appendix 4 As
expected the higher impact on the EDPrsquos value come from the weather
conditions since as already mentioned EDP has a large hydro installed capacity
However one can conclude that austerity measures can also have a substantial
impact in EDPrsquos value
Figure 76 EDPRrsquos growth plan
Source EDPR
US60
EmergingMarkets
20
Europe
20
Figure 77 SOTP (euro)
Source Analystrsquos estimates
1028
354
- 028 1083 - 041 - 504
- 169385
182
253
276
Generationamp Supply -
Iberia
Reg Electr -Iberia
Non-hydroRenewables
Brazilian Op Holding ampOther
OperatingValue
Non-operating
items
EnterpriseValue
Net Debt Minorityinterests
Equity Value
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3537
APPENDIX
APPENDIX 1 ndash Comparables Analysis
Source Bloomberg Country PE EVEBITDA Dividend Yield () Net DebtEBITDA
Liberalized Iberia
Iberdrola Spain 1329 874 057 076
EDF France 1339 474 495 076
EON Germany 1326 488 431 062
RWE Germany 1177 483 349 076
Regulated Iberia
REE Spain 1596 1058 411 064
REN Portugal 1142 758 653 194
Enagas Spain 1385 926 546 073
Brazil
CPFL Energia Brazil 1951 959 512 085
Tractebel Energia Brazil 1555 126 66 012
CIA Paranaense Brazil 836 586 915 073
APPENDIX 2 ndash Macroeconomic indicators (Source IMF)
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019
Portugal GDP growth 194 -125 -323 -135 117 145 168 180 184 184
Inflation 139 356 278 044 067 120 147 151 148 150
SpainGDP growth -020 005 -164 -122 087 096 113 117 121 127
Inflation 204 305 244 153 027 084 090 104 102 105
BrazilGDP growth 753 273 103 228 182 265 300 315 334 351
Inflation 504 664 540 620 592 554 530 515 500 475
APPENDIX 3 ndash Evolution of PPACMECs power plants ndash ending concession date MW transferring at the end of
the concession date and maturity of those power plants (Source EDP)
Ending Concession Year 2009 2010 2012 2013 2015 2017 2020 2022 2024 2027
HydroTotal MW 804 627 132 125 2215 192
BegOp 1958-1995 1951-1964 1974 1987 1956-1994 2005
CoalTotal MW 1180
BegOp na
Fuel-oilTotal MW 56 710 946
BegOp na na na
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3637
APPENDIX 4 ndash Sensitive Analysis Results (Source Analystrsquos Estimates)
Factor ChangeNew target
price Difference from
TP15E
Regulation Take off the inflation update factor 322 -9
Weather Reduce load factors in 2 each year 311 -12
Exchange rate- 1 EURBRL 360 1
+ 1 EURBRL 349 -1
Financial - 1 GDP -1 Inflation 342 -3
WACC and g sensitive analysis
APPENDIX 5 - Financial Statements
Millions of Euros 2013 2014 2015E 2016E 2017E 2018E 2019E
Income Statement
EBITDA 3617 3642 3677 3655 3678 3648 3675
Depreciation and Amortization -1532 -1449 -1460 -1450 -1438 -1426 -1402
EBIT 2085 2193 2217 2205 2240 2222 2272
Net Financial Costs -737 -572 -665 -661 -672 -667 -682
Other Results 34 15 24 25 21 23 23
Profit before income tax 1382 1636 1576 1568 1589 1579 1614
Income tax expense -188 -311 -465 -463 -469 -466 -476
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Attributable to
Equity holders of EDP 1005 1040 934 929 942 936 956
Non-controlling Interests 188 223 177 176 179 177 181
Net profit for the year 1194 1264 1111 1105 1120 1113 1138
Balance Sheet
Net Fixed Assets 29640 29657 30777 30732 30634 30762 30765
Receivables 8043 7544 8096 7895 7916 7836 7817
Other Assets 2786 3058 2772 2759 2763 2786 2788
Total Assets 40470 40259 41645 41386 41313 41384 41370
Net Financial Debt 17981 17684 18432 17903 17417 17542 17084
Payables 5126 4868 5108 5039 5021 4790 4804
Other Liabilities 5834 5738 5846 5802 5832 5624 5639
Total Liabilities 28941 28290 29386 28744 28269 27956 27527
Total Equity 11529 11969 12259 12642 13044 13429 13843
Total Equity and Liabilities 40470 40259 41645 41386 41313 41384 41370
Cash Flow Statement
NOPLAT 1725 1707 1563 1554 1579 1566 1602
Operating Gross CF 3257 3156 3023 3004 3018 2992 3004
Capex -407 -1466 -2580 -1405 -1340 -1554 -1405
Change in NWC -13 439 -568 73 -1 -395 37
Operating FCF 2836 2129 -125 1673 1676 1044 1636
Lib IberiaWACC
4 576 7
g
15 486 337 290
20 554 354 298
25 668 377 309
Reg IberiaWACC
4 541 7
g
15 417 335 293
20 470 354 302
25 558 380 313
BrazilWACC
6 779 9
g
4 433 329 300
5 558 354 314
5 642 366 320
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice
EDP ndash ENERGIAS DE PORTUGAL COMPANY REPORT
PAGE 3737
DISCLOSURES AND DISCLAIMER
Research Recommendations
Buy Expected total return (including dividends) of more than 15 over a 12-month
period
Hold Expected total return (including dividends) between 0 and 15 over a 12-month
period
Sell Expected negative total return (including dividends) over a 12-month period
This report was prepared by Daniela Gameiro a student of the NOVA School of Business andEconomics following the Masters in Finance Equity Research ndash Field Lab Work Project exclusivelyfor academic purposes Thus the author which is a Masters in Finance student is the soleresponsible for the information and estimates contained herein and for the opinions expressed whichreflect exclusively hisher own personal judgement This report was supervised by professor RosaacuterioAndreacute (registered with Comissatildeo do Mercado de Valores Mobiliaacuterios as financial analyst) who revisedthe valuation methodology and the financial model All opinions and estimates are subject to changewithout notice NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report norfor any consequences of its use
The information contained herein has been compiled by students from public sources believed to be reliablebut NOVA SBE or the students make no representation that it is accurate or complete and accept no liabilitywhatsoever for any direct or indirect loss resulting from the use of this report or its content
The author hereby certifies that the views expressed in this report accurately reflect hisher personal opinionabout the subject company and its securities Heshe has not received or been promised any direct or indirectcompensation for expressing the opinions or recommendation included in this report
The author of this report may have a position or otherwise be interested in transactions in securities whichare directly or indirectly the subject of this report
NOVA SBE may have received compensation from the subject company during the last 12 months related toits fund raising program Nevertheless no compensation eventually received by NOVA SBE is in any wayrelated to or dependent on the opinions expressed in this report
The Nova School of Business and Economics though registered with Comissatildeo do Mercado de ValoresMobiliaacuterios does not deal for or otherwise offers any investment or intermediation services to marketcounterparties private or intermediate customers
This report may not be reproduced distributed or published without the explicit previous consent of its authorunless when used by NOVA SBE for academic purposes only At any time NOVA SBE may decide tosuspend this report reproduction or distribution without further notice