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'Near-term catalysts' materializing for European utilities

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Some of the biggest names in the European utility sector have had a potentially transformative year so far, with analysts closely watching for additional details on major strategic shifts and key corporate milestones during third-quarter earnings reports.

Companies including French utilities Engie SA and Electricité de France SA, and Germany's RWE AG and Uniper SE, have been navigating new terrain in 2019 and could benefit from near-term milestones to unlock investor value.

"These are perhaps not the prettiest faces in the sector, by convention, but they all have value and catalysts, making them attractive if we look beyond the immediate macro," Sam Arie, managing director of utilities research at UBS, wrote in a recent research note.

Several European utilities analyzed by S&P Global Market Intelligence, including six of the 15 largest by market capitalization, are expected to beat their earnings performance from last year's third quarter, although analysts estimate that many could fare worse than during the second quarter this year.

The only utilities analyzed that are expected to outperform their second-quarter results, either measured by outright EBITDA or EPS, are Spanish groups Iberdrola SA, Naturgy Energy Group SA and Endesa SA.

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A particularly close eye will be cast on RWE and its German rival, E.ON, which are wrapping up the largest deal in the sector this year by carving up former RWE subsidiary Innogy SE between them.

The close of the transaction is a "major near-term catalyst" for both companies, said Peter Crampton, director of European utilities research at Barclays.

"Investors are still ignoring RWE's transformation into Europe's third-largest renewables player," Crampton wrote in a note. That is despite the company's shares surging by more than 40% so far this year. However, the company has already provided details on its strategic priorities around its new renewables-heavy portfolio, so investors may be looking in vain for more depth.

But Crampton said that RWE will also need to include its new renewables assets and additional minority stakes in German nuclear plants in its full-year guidance for the first time, which should give the company a boost heading into the final months of the year. In July, RWE already increased its full-year EBITDA guidance from between €1.2 billion and €1.5 billion to between €1.40 billion to €1.7 billion on the back of a surprisingly strong result in its commodity trading division.

For E.ON, investors will likely focus on how the company plans to handle its two struggling U.K. retail companies. In addition to its legacy business in the country, E.ON also absorbed Innogy's loss-making Npower division in the asset swap.

E.ON has hinted that it might seek to offload the business as quickly as possible and promised to lay out its plan for how to deal with the issue after the takeover of Innogy is complete. Npower already lost 238,000 customers year over year during the first half of 2019 and Innogy said in August that it expects the unit to post an adjusted operating loss of €250 million for the full year.

Another potential deal under the microscope is Finnish utility Fortum Oyj's bid for control of another German power producer, Uniper. After protracted talks that ended nowhere, the company announced this month that it is buying a further 20.5% interest in Uniper for €2.3 billion, paving the way for deeper long-term integration and a range of synergies long touted by Fortum CEO Pekka Lundmark, specifically in Sweden and Russia.

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The deal will also give Fortum access to Germany and other continental European markets where the pair have very little overlapping businesses, as well as Uniper's large number of gas assets.

Gas plants in general have been running at higher levels this year across Europe, displacing coal amid low gas and high carbon emission prices. Czech utility CEZ a. s., Poland's PGE Polska Grupa Energetyczna SA and Spain's Endesa, owned by Italy's Enel SpA, are expected to earn less than during last year's third quarter. The companies all operate large coal fleets, although they also run gas plants.

On the corporate front, analysts are likely to seek further clarity from France's state-controlled EDF on its planned restructuring, with a rumored proposal on the horizon to split the company into a state-owned nuclear holding company and a partly listed subsidiary carrying renewables and other business lines.

EDF's nuclear plans suffered setbacks this month, incurring additional delays and cost overruns for new projects in both the U.K. and France, and management is also expected to provide an update on the state of its existing fleet, which has been plagued by structural issues. Those issues could put the utility's management on the defensive, especially as EDF has already lost almost a third of its market value this year, making it one of the worst performers in the sector.

Meanwhile, things may be looking up for France's other large utility, Engie, which suffered from outages in its Belgian nuclear fleet in 2018 and has said that financial performance will accelerate during the second half of this year.

Barclays' Crampton said he expects the utility to beat results estimates for the second quarter in a row in November, potentially resulting in full-year net recurring income towards the upper end of the €2.5 billion to €2.7 billion guidance range. He added that investors are increasingly won over by CEO Isabelle Kocher's focus on growing Engie's client solutions business, as well.

"In our view, Engie's current share price is not representative of its asset quality, cash generation power and medium-term EPS outlook," Crampton said.