Elia Group SA/NV (ELI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for holding and welcome to the Elia Group First Half 2020 Results Webcast and Event Call. [Operator Instructions] I would now like to hand over the call to Yannick Dekoninck. Go ahead, please, sir.

Good afternoon. First, we would like to offer you a warm welcome to all of you who have joined us today for the half year results of the Elia Group. We hope that you, your family, friends and colleagues are all safe and well during these extraordinary times. Present in this call are group CEO, Chris Peeters; and our group CFO, Catherine Vandenborre with me in room. Chris will first present the highlights of the year, while Catherine will walk us through the figures for the first half of the year. Afterwards, both will answer your questions. Chris, please go ahead.

Thank you, Yannick, and good afternoon, everyone. During today's call, we will start with the highlights of the first half of the year, followed by the financial performance and conclude with the outlook for the rest of the year. First, I would like to spend some time on the impact of COVID-19 on the Elia Group. The crisis created by COVID-19 virus and the measures required to contain the expansion tested the capability of response of all individuals, companies, institutions, governments and us. Moreover, thanks to all the efforts and sense of duty of all women and men at Elia Group, I can say that we're doing our part to contribute. Since the outbreak of the crisis, Elia Group has demonstrated to be a resilient organization. Despite the extraordinary and unprecedented circumstances, most of the operational activities continued, driven by our socioeconomic importance and our vigorous efforts to ensure a stable and secure electricity system in the interest of society. We have put in place a comprehensive set of measures to ensure the continuity of supply and to protect the health and safety of our employees, contractors and customers. Our investments in digitalization of processes and platforms have allowed up to 95% of our office employees to work remotely. For those areas where working from home is not possible, like in the dispatching, we have taken all precautionary measures to minimize the risk of contamination. From an operational point of view, we experienced delays in Belgium due to the absence of contractors on some work sites, leading to a downward revision of our investment program by 16% to EUR 285 million. Today, the situation has completely normalized. In Germany, given different lockdown measures, construction works continued or even slightly accelerated in some cases. Electricity consumption has also been impacted by the lockdown measures. In Belgium, electricity consumption has started rising again and is gradually returning to normal. At the height of the lockdown in early April, electricity consumption in Belgium was down as much as 17% on average. The average price of electricity is also on the rise after dropping to an all-time low of EUR 14.7 by -- per megawatt hour in April. In Germany, 50Hertz recorded an average drop in consumption of only 8% as many sectors largely remained up and running. The slightly lower consumption, combined with a large supply of renewable energy, allowed 50Hertz to set a new record in the first half of 2020. 65% of electricity demand was covered by renewables, mainly wind and solar energy. From a financial view, considering that the bulk of Elia Group's cash flow and financial performance are insured through a regulated framework, COVID-19 has no major impact on the group's financials. I would like to remind you that we do not have a net profit impact from drop in volumes. As such, drops in revenues are recoverable through future tariffs according to the regulatory frameworks. We also have no cash impact as the declines in revenues were offset by equivalent reductions in costs, particularly in the purchase of ancillary services. We have not recorded significant change in payment habits, and therefore, we have no material increase in outstanding payments. Finally, Elia Management Committee, Board of Directors and employees also supported those most in need by donating a total of EUR 355,000 to different funds at the King Baudouin Foundation. As we have spoken about the present situation, it's now time to have a look into the future. A question popping up is how can Elia Group contribute and accelerate the sustainable recovery towards a greener economy. With the phasing out of the COVID-19 measures, major economic stimulus plans are being prepared. The European Green Deal has been at the forefront of the news and will be used as a compass given Europe's aim to be first climate-neutral continent by 2050. In our role as system operator, we want to support society's economic recovery and at the same time, contribute to the decarbonization of society. Hence, we see sustainability being a cornerstone of many COVID-19 recovery initiatives. In line with our mission to serve society, Elia Transmission has come up with a number of tangible recovery measures that will drive long-term growth. We are currently in discussion with some critical stakeholders in Belgium. Most of the proposals could be implemented relatively quickly and immediately create local jobs since they involve infrastructure work that benefits society as a whole. We, therefore, believe that Belgium's future recovery program is an important driving force for change. By accelerating no regrets investments that pave the way to a decarbonized and digital society, we could contribute to a positive societal project that will benefit the prosperity of future generations. In Germany, 50Hertz has launched the objective of covering the electricity demand in its grid area with 100% renewable energy by 2032. This is also in line with the ambitions of the European Green Deal. The objective emphasis, the pioneering role that 50Hertz is playing in the integration of large quantities of renewable energy production in both German and European energy systems. However, achieving this 100% target requires special commitment, not only in our own company, but also in politics, business and society. It will be essential to develop more suitable areas for onshore and offshore wind power and to include them in land development plans in a timely manner. We still see great potential in the Baltic Sea, in particular. In order to finance the necessary investments in the grid infrastructure, Eurogrid GmbH issued the first green bond. The proceeds will be used to finance the offshore renewable projects, namely Ostwind 1 and Ostwind 2. And I hand now over to Catherine.

Thank you, Chris. And before we get into more details on the results, I would like to take you through the Belgium regulatory framework as we have started on the 1st of January, a new period, which covers the next 4 years until 2023. The regulator opted for stability with the new tariff methodology broadly remaining in line with the general principles of the previous regulatory period. So the Belgian regulatory framework remains based on a cost-plus model, with coverage of all reasonable costs, including a fair remuneration and completed by various incentives of which the achievement remains linked to operational targets. Secondly, the embedded debt principle remains applicable with cost of debt coverage by the tariffs. And as mentioned, there is no risk on volume neither credit risk. The main change of the framework is related to a revised computation of the equity-based remuneration. First, the risk-free rate is fixed ex ante at 2.40% for the whole period and replaces the average 10-year OLO for the year. Second, the regulatory gearing increases from 1/3 to 40% equity, hence, the capital increase realized in 2019. And finally, the market compensation disappears as most of the strategic interconnection projects are commissioned and is replaced by higher fair remuneration following the revised computation and additional incentives. Those are intended to encourage Elia to further enhance the operating performance of the regulated activities in Belgium. Finally, the composition of the regulatory asset base has slightly changed as intangible assets are now activated in the hub while levies are excluded as from 2020. Both change years have a marginal effect on the RAB. As mentioned before, we expect to generate a return of approximately 6% after tax over the regulatory period. Let us now turn to the overall performance through the first semester of 2020. We have invested, so far, EUR 326 million in the development of the electricity infrastructure, in order to integrate an increasing number of onshore and offshore renewable generation capacity in the electricity system, to further interconnect the neighboring regions and to maintain the network. In Belgium, Elia Transmission invested EUR 134.7 million. In contrast to last year's historical investment levels, 2020 is characterized by the commissioning and closing of an important wave of investments. The main investments are linked to: first, upgrading existing corridors like the Mercator-Horta project, one of the backbones of the Belgian electricity grid, built in the '70s for element of EUR 20 million; and also the Brabo Phase 2 project, aiming at improving security of supply in Antwerp region, amounting to around EUR 15 million, and which is well advanced and is working towards commissioning by end 2020. Second, Elia invested around EUR 56 million to further strengthen the grid. This includes many projects like replacement of a 150-kV cable in the south of Brussels, all replacement of existing installations to equip those with latest technologies and make them robust for the future. Finally, we did renewable investment of close to EUR 15 million. At the end of May, the Seastar wind farm was connected to the Modular Offshore Grid, and it marked the completion of this installing project. Located 40 kilometers off the Belgian coast, the switching platform bundles together the export cables from 4 offshore wind farms and transports the generated energy to the mainland via a shared transmission system. In Germany, we have invested EUR 191.3 million. Offshore investments amounted to EUR 51.4 million and mainly concern the offshore grid connection of Ostwind 2. Onshore investments amounted to EUR 140 million. The major investments are linked to: first, the commissioning of a 380-kV overhead line between Stendal West and Wolmirstedt boosting transmission capacity in order to integrate wind energy into 50Hertz's grid. This is the first step in replacing a 220-kV line dating back to the '50s. Its upgrade is necessary to get the large-scale wind energy production efficiently from the north of Germany to the consumption centers in the south and thereby further reducing the redispatching costs caused by grid congestion. Also for the SuedOstLink project, good progress has been made. The Federal Network Agency formally started the planning approval procedures for 2 important sections. Furthermore, after a long tendering process, the contract to design, manufacture and lay a 1,000-kilometer long underground high-voltage interconnection has been awarded. Construction is scheduled to begin in 2022 and will take 4 years. With a capacity of 525 kV, the underground cable will be able to transmit larger volumes of energy. Finally, 50Hertz made other investments, mainly related to upgrading high-voltage pylons to boost operational safety or reinforcing the 380-kV cable in Berlin. In terms of financial results, the adjusted net profit of the Elia Group share declined by 3.6% to EUR 148.8 million. This decrease comes from lower results in Belgium and in the nonregulated and Nemo Link segments, and is partially offset by a strong performance in Germany. The net profit of the Elia share decreased by 4.8% to 100 -- sorry, to EUR 120.1 million for the same reasons and taking into account over 80% shareholding at 50Hertz and a hybrid coupon. Finally, we succeeded in maintaining grid availability at a very high level of 99.99%. Going now into details through the results themselves. Elia Group revenues totaled EUR 1.176 billion, representing a 1.4% increase compared to the previous period. This increase was driven by higher revenues in Germany, up EUR 32.5 million and higher revenue from EGI of around EUR 4.5 million, partly offset by lower revenues in Belgium, which declined by EUR 28 million. The decline in revenues in Belgium follows a reduction of some costs that are passed through in revenues according to the cost-plus model and new tariffs applicable in 2020. In Germany, revenues increased mainly due to higher energy revenues, which include all operating revenues relating to system operations. The EBIT remained flat compared to the previous period, amounting to EUR 281.1 million. This is the result of a lower EBIT in Belgium, decreasing by EUR 15.2 million, offset by a higher EBIT in Germany of EUR 14.2 million. For Belgium, the decrease results for (sic) [ from ] lower financial costs and lower taxes, which both being passed through into revenues and a change in the regulatory treatment of intangible assets. This decrease is partially offset by an increase in the regulated net profit driven by higher equity remuneration and incentives with the start of a new regulatory period. In Germany, the higher EBIT is due to higher investment remuneration, partially offset by higher depreciation, higher personnel and IT costs. Like mentioned in the highlights, the adjusted net profit of the Elia Group decreased by 3.6% to EUR 148.8 million. Elia Transmission achieved a result of EUR 61.5 million, representing a decline of EUR 3.5 million year-over-year. The lower result is due to the disappearance of a one-off positive impact of last year's capital increase and the depreciation of intangible assets acquired prior to 2020, which derived from the new tariff methodology, but is partly offset by higher equity remuneration and higher performance on incentives. 50Hertz recorded an adjusted net profit of EUR 94.5 million, which increased by EUR 10 million versus last year. This increase is mainly driven by higher investment remuneration following asset growth, the release of a one-off provision following the acceptance of historic cost by the regulator and lower financial costs, partially offset by higher OpEx and depreciation costs linked to the commissioning of Ostwind 1 in 2019. The nonregulated segment and Nemo Link posted an adjusted net loss of EUR 7.2 million. This loss is mainly due to operational expenses of the holding activity, the nontax deductibility of the interest costs for the senior and hybrid debt lodged at the holding level and cost for the development of re.alto, which was set up in the second half of 2019. Despite a strong operational performance of Nemo Link, the net contribution to the group was lower due to a one-off preferential dividend payment to National Grid, in reimbursement of past project costs borne at the time directly by National Grid. Elia chose to reinvoice Nemo Link for the cost it had incurred for the implementation of the project. Taking into account the adjusted items related to the final cost settlement for the corporate reorganization realized at the end of 2019, the Elia Group net profit decreased by 2.3% to EUR 148.6 million. Excluding the noncontrolling interest and considering the accrued coupon for the hybrid, the net profit attributable to Elia shareholders came in at EUR 120.1 million. Looking at net debt. At the end of June, we carried a total net financial debt of around EUR 6.4 billion. The increase in net debt is mainly driven by: first, a strong decline of the EEG cash position in Germany by EUR 655.8 million and resulting from a combination of a high wind infeed and electricity prices remaining on a low level due to decreased consumption, which led to lower cash-ins from collected surcharge. We will come back to this into detail when discussing the German segment. Secondly, the investment program was mainly financed by cash flow from operating activities and external debt. Both Eurogrid and Elia Transmission tapped the debt markets for a total amount of approximately EUR 1.7 billion for financing infrastructure of the future and strengthening the liquidity position. Elia coupon had fixed rate debt outstanding and lowered further the average cost of debt by 17 basis points to 1.96%. The rating of the Elia Group remained unchanged during the first half of 2020 with a BBB+ rating and a stable outlook. Now let's take a more detailed look at the underlying performance of the different segments, starting with Elia Transmission. Revenues for the first month decreased by 5.6% to EUR 471.1 million. Revenues were impacted by lower financial costs driven in 2019 by the capital increase and lower cost for ancillary services, but partially offset by a higher regulated net profit, which are all passed through into revenues. The adjusted net profit decreased by 5.4% to EUR 61.5 million. In more detail, the key drivers are: first, as mentioned already, last year's adjusted net profit benefited from a one-off positive compensation for the cost linked to the capital increase of EUR 6.3 million. Excluding these one-off effects, we remarked a slight decrease in the results under the first year of new regulatory framework. In particular, the fair remuneration increased by EUR 28.7 million to EUR 49.3 million. This increase is primarily driven by the higher return on equity and a higher gearing ratio. Also, the contribution from incentives increased slightly to EUR 10.2 million. Both the increase in fair remuneration and incentives are more than offsetting the termination of the mark-up compensation under the new regulation. Furthermore, the result was negatively impacted by a change in the regulatory treatments of intangible assets. In the past, the cost of IT developments were borne in the year of the completion and covered by the tariffs in the same year. As of 2020, the regulatory framework imposed a capitalization of the expenses, the depreciation being covered by the tariffs. Since IFRS rules have always required the capitalization of these expenses, we have, in 2020, higher depreciation of software acquired prior to 2020 and activated under IFRS while fully expensed and covered by tariffs under the previous tariff methodology. Finally, the result was positively impacted by the reversal of tax provision, partially offsetting the slight increase in IAS 19 provisions driven by lower discount rates. From a balance sheet perspective, Elia Transmission Belgium has a solid capital structure, with an equity portion slightly above 40% of the regulated asset base. The equity increased slightly since year-end, driven by the half year net profit, partly offset by the allocation of regulated equity to Nemo Link to align its financing in accordance to the current regulatory framework, being 40% equity and 60% debt. From a debt capital market perspective, Elia Transmission had a busy 6 months. In April, Elia tapped the debt market by issuing an EUR 800 million Eurobond at a fixed rate of 0.875%. It was Elia's largest operation at the lowest coupon ever and is fully to the benefit of consumers. The proceeds were used to refinance a EUR 496 million shareholder loan which matured in June 2020. By this transaction, the liquidity position of Elia was strengthened, and we benefited from the low coupon to further lower the average cost of debt to 1.95%. The liquidity position was further enhanced by repayments of the EUR 75 million RCF that was drawn at the end of December 2019. In addition, a new commercial paper program was put in place for an amount of EUR 300 million fully undrawn today. Elia Transmission has a well-balanced debt maturity profile with a weighted debt duration of 6.96 years with no upcoming near-term material maturities. At 50Hertz, the revenues increased by 4.9% to EUR 697.2 million compared to the first half of 2019. Revenues were mainly impacted by higher charges to the other German TSOs as costs for reserve power plants in the 50Hertz equipped region have risen. 50Hertz realized solid result over the first half of the year. The adjusted net profit increased by 11.8% to EUR 94.5 million. Looking at the key items of the results, we remark that: first, the investment remuneration increased by EUR 19.3 million. This is driven by the ongoing investment program in growing asset base. The counter effect of this growth is visible in the depreciation affecting our results negatively by EUR 12.9 million mainly due to the commissioning of Ostwind 1 at the end of 2019. Secondly, following a review by the regulator of historic costs, a provision for non-influenceable cost was released, leading to a positive effect of EUR 6.3 million. The financial results increased by EUR 2.0 million as interest on provisions were lower and more borrowing costs were capitalized. The revenues granted via the base year mechanism increased in line with inflation by EUR 1.2 million. Finally, the OpEx cost increased by EUR 5.9 million, mainly due to higher personnel and IT costs, driven by our continuous efforts towards digitalization and the expansion of our business. We would like to take a closer look at the evolution of the EEG cash position. As per the end of June, 50Hertz has a deficit of EUR 225.3 million on the EEG accounts, while in the past, large excess cash balances were reported. As a reminder, the EEG mechanism grants compensation to renewable energy operators for the electricity they feed into the grid. This compensation is paid via the EEG surcharge, which is fixed for 1 year and handled by the German TSOs who are responsible for trading this electricity on the power exchange. All arising costs are passed on the surcharge and therefore neutral for the TSOs. In 2020, a combination of several factors resulted in a cash deficit. First, the renewable infeed increased significantly since December of 2019, on the back of favorable weather conditions, leading to higher payments to [ house ] producers while electricity prices are on a low level. Furthermore, the consumption fell due to COVID-19, leading to lower cash-ins from the collected surcharge. Consequently, 50Hertz faces currently a deficit on the EEG balance that is expected to increase over the next month. In this respect, an additional revolving credit facility of EUR 400 million has been contracted per half year and solely for the purpose of EEG financing. At this stage, all the existing revolving and overdraft facilities remain undrawn. Important is also that all funding costs are fully charged to the EEG mechanism so that this represents temporary deficit that will be settled in 2021. To avoid further deterioration, the legislation has been recently adapted. Driven by the German climate package, the funds from the mandatory CO2 certificate sales will flow into the EEG account from 2021 onwards. And to additionally relieve the German consumers in the COVID-19 crisis, the government decided to restrict EEG surcharge in 2021 to EUR 0.065 per kilowatt hour while it currently lies at EUR 0.0676 per kilowatt hour. Finally, to cover the high deficits and additional funding costs of the 4 German TSOs, a grant which includes the inflow from CO2 certificate sale of up to EUR 10.8 billion was set in place. The payoff mechanism is currently under discussion. A possibility is to settle the deficit with the first payment in January, while the second and maybe third payout in May and October could avoid new funding needs in 2021. From a balance sheet perspective, the equity remains strong and stable. Early May, Eurogrid GmbH successfully issued its debt Green Bond for EUR 750 million fixed coupon of 1.1%. This senior unsecured bond is based on Eurogrid's Green Bond Framework, and its proceeds will exclusively be invested in a portfolio of offshore renewable electricity project, namely Ostwind 1 and Ostwind 2, and as such, directly contribute to the further decarbonization of society. Despite the high cash need for EEG, the liquidity position of 50Hertz remained strong, slightly above EUR 2 billion, with all revolving and overdraft facilities fully undrawn. The maturity profile is well balanced with a weighted debt duration of 6 years and the payback of a EUR 500 million Eurobond in autumn this year. There has been no change to the rating of Eurogrid GmbH, which remains a BBB+ with stable outlook. Looking at the third segment, which represents our nonregulated activities as well as Nemo Link, this segment reported a net adjusted loss of EUR 7.2 million. The key drivers are: first, the holding costs, which increased by EUR 5.5 million. This increase is due to the fact that the interest cost for the nonregulated senior and hybrid bonds are no longer tax deductible, as Elia Group does not have sufficient operating income to absorb the financial cost in accordance with the new tax rule implemented in 2019 from assessment year 2020. In addition, the holding incurred some operating expenses. Secondly, the contribution from Nemo Link decreased by EUR 2 million. For the first semester, Nemo Link had a stronger operational performance reflected by very high overall availability of 99.8% and a financial performance well above the flow with a result of EUR 12.7 million. However, the net contribution to the group was negatively affected by a one-off preferred dividends paid to National Grid. Also, during the first half, we continued the development of a European market platform named re.alto, by which we want to facilitate the exchange and valorization of data and digital services. As per end of June, costs have incurred amounting to EUR 900,000. Following the review of the standard in 2019, the Belgian regulator rejected for EUR 2.7 million of cost as part of their yearly review. Order decreased by EUR 1 million, representing the higher funding cost for Nemo Link, slightly better performance by EGI and lower nonregulated costs. From a funding perspective, we issued in May an amortized private placement of EUR 200 million at 1.56% as the previously issued Nemo Link dedicated loan was converted into a general-purpose loan at the end of 2019 upon request of the regulator. What remains is the outlook for 2020. Like mentioned in the highlights, Elia Group operational activities continued, largely driven by the socioeconomical importance and the group's vigorous effort to ensure business continuity. Elia Group has further assessed the potential quantitative impact of the situation resulting from the management of COVID-19 results. And we conclude that given the largely regulated nature of our business, the impact on the expected results of 2020 is not material. Elia Group remains confident to realize an adjusted return on equity between 6.5% and 7.5%. This return depends on the return on equity of the regulated activities in Belgium and Germany and also on the nonregulated activities and operating costs inherent to the management of the holding company. In Belgium, we remain confident in achieving a return on equity of between 5% to 6%. Following the lockdown measures taken by the government, some construction sites were temporarily stopped or delayed. We are today on track to realize investment of EUR 285 million as announced in Q1. The results forecast for Germany remained positive. Since the lockdown measures enacted in Germany differ to those in Belgium, work was able to continue at all construction sites or even accelerated, leading to investment expected to total around EUR 725 million in 2020. We remain confident in our ability to deliver a return on equity in the upper end of the targeted 9% to 11% range. With those investments in Belgium and Germany, and considering the realization of the investment plan, which is always prone to some certain external risk, we expect for 2020 a total RAB of EUR 9.7 billion. This brings us to the end of the presentation. We still would like to share the milestones moments for the financial communication in 2020 and open the floor for questions.

[Operator Instructions] The first question comes from Mr. Bart Jooris, Degroof Petercam.

First of all, regarding the tax deductibility of the hybrid and senior debt costs which are at the holding level, your income level is now too low to get to that. Do you have any plans to bring that income level up by some kind of reorganization so that those costs can become deductible again? And then secondly, are there still negotiations or discussions going on in Germany with the regulator concerning past costs that could be released from provisions in the future?

Yes. Thank you for your question. Regarding the first one on the tax deductibility of the holding cost. First element is that the legislation is rather new, and I don't know to which extent all the details are well known. But the fact is that in case of a reorganization, which has been the case with the setup of TopCo, the nondeductibility of the interest rate is limited to a period of 5 years. So that's the first element of your answer. We have, today, an absence of tax deductibility, which, by law, is limited to a 5-year period. Second element, yes, we are looking at possible means to soften the impact of the nontax deductibility earlier, so before the 5 years period. But there are no obvious or easy means, and we cannot guarantee that a solution will be found before this 5-year period. Second question regarding the discussion with the regulator in Germany. Yes, there are a number of elements, which are still in discussion with the regulator. Like always, when there are discussions with the regulator, the outcome is uncertain as long as the discussion is not finalized. So that's premature to give you a complete detail today of the possibilities or different elements that could occur. That being said, we are close to finalize a number of discussions. And when we are revising the guidance for Germany, mentioning that we expect to finalize 2020 at the upper end of the range, we take into consideration a number of elements linked to discussions with the regulator.