Dong’s new focus pays off

Nigel Hawkins assesses Dong Energy’s prospects in the wake of a successful IPO, its announcement that it will quit coal-fired generation and sell most of its oil and gas assets.

Despite some challenging times in recent years, Dong Energy’s star is rising. The Danish government still holds a majority stake in the energy company, but a pivotal initial public offer (IPO) last summer proved very popular, and attracted some 36,000 new investors.

Dong’s timing has been key. Investment interest in wind power has risen in recent years, and Denmark’s long-standing reputation in generating wind power has placed Dong firmly on the map.

Indeed, Dong’s most recent headline-grabbing initiative was its announcement that it would exit coal-fired electricity generation by 2023.

Aside from the environmental rationale behind the decision, the fact that Dong’s power division reported a loss of DKK607 million in 2016 at the earnings before interest, tax, depreciation and amortisation (Ebitda) level must also have played a part.

Although it is true that Dong’s share price has barely moved in the eight months since the IPO, it has nonetheless remained solid – something that cannot be said for that of France’s beleaguered EDF.

As such, Dong’s market capitalisation is now close to DKK106 billion, which puts it in the second tier of EU energy companies.

Its full-year figures for 2016 were recently published and – given how central they were to the IPO process – they contained no real surprises. Indeed, as Dong’s chief executive Henrik Poulsen confirmed, “the results for 2016 are highly satisfactory”.

As expected, the figures were split between the overall returns and those that omit Dong’s oil and gas assets – some of which are based in Norwegian seas – that are slated to be sold.

In re-focusing Dong on the renewable power market, a decision has been made to sell most of its oil and gas assets: its Ebitda return fell by about a third in 2016 compared with figures for 2015. The recent rallying of oil and gas prices should, though, boost proceeds.

Overall revenues for the continuing businesses – omitting the to-be-sold oil and gas assets – in 2016 exceeded DKK61 billion, compared with over DKK65 billion in 2015.

Importantly, however, there was a sharp turnaround at the Ebitda level, with the overall Ebitda figure from continuing operations at DKK19.1 billion, compared with just DKK8.7 billion in 2015.

At the net profit level, continuing operations contributed DKK12.2 billion: the discontinued component was a more modest DKK1.1 billion.

There were, though, some material one-off capital gains in 2016 – such as the sale of 50 per cent of the 573MW Race Bank off-shore windfarm to Macquarie. These flattered the overall numbers.

Hence, Dong’s own projections for 2017 are for an Ebitda return within the range of DKK15-17 billion; such figures imply underlying growth of between 4 and 18 per cent.

The key driver behind Dong’s improving figures is unquestionably wind generation: it now has an installed off-shore capacity of 3.6GW. In the fourth quarter of 2106, the portfolio was operating with a load factor just below 50 per cent.

Participating in the rapidly developing UK offshore wind market remains a priority for Dong. Indeed, it has been far more aggressive in this respect than any of the big six integrated energy suppliers, with the possible exception of SSE.

Its most high-profile UK project in recent years has been the first phase of the 630MW London Array, in which it owns a 25 per cent stake.

The second most important component of Dong’s Ebitda is its earnings from its distribution and customer solutions operations, much of which are either price regulated or covered by long-term contracts.

In 2016, the Ebitda return from this division exceeded DKK7.1 billion, a figure that was inflated by a one-off DKK4.3 billion gain from renegotiated gas contracts.

In terms of net debt, the base figure of just DKK3.5 billion appears low. However, once other long-term liabilities are taken into account, the figure rises to DKK18.0 billion.

Clearly, ongoing capital expenditure will be a key determinant of the company’s longer-term net debt profile. Capital expenditure of at least DKK15 billion a year is expected until 2020: over 80 per cent of this figure is earmarked for wind generation investment.

More specifically, a large part of this budget will help fund the development of the massive Hornsea Project 2, where a vast number of turbines will be installed about 55 miles off the Yorkshire coast.

Irrespective of Hornsea Project 2 and other more standard capex requirements to fund over the next few years, there should still be scope for acquisitions. It is not clear exactly what Dong will target, but offshore wind investment in the Baltic Sea area should provide some interesting opportunities.

Certainly, Dong will be pleased with both the outcome of last summer’s IPO and its 2016 full-year results.

Of course, there is a likelihood that government subsidies – which are generous at present – will be sharply reduced or even removed. Discerning investors must make allowance for such political whims.

Hence, wind power operators are focusing on both improved plant performance and substantial unit cost reductions.

And, unlike some of the larger players, such as EDF, RWE and Eon – all of whom have seen dreadful share price performances over the past decade – Dong seems comparatively well-placed.