Polish Energy Utilities - Bankier.pl · 2014-11-12 · Polish Energy Utilities ... While the LT risks for PL Utilities relate above all to their huge CO2 ... EUR RWE AG RWE GR Not

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FUNDAMENTAL INSIGHT

CE3 | Utilities | 5-November-2014

Polish Energy Utilities

The attraction of dividends

While the LT risks for PL Utilities relate above all to their huge CO2

intensity and more stringent EU environmental regulations still persist,

we believe that investors’ key focus in the short- and medium term

should be on the improved earnings outlook (2013-16E EBITDA CAGR

around zero on a sector level, but BUY-rated Energa and Enea offer

respective 5% and 4% growth rates) and healthy dividends offered

(2015E DY ranging from 3.2% for Tauron to 4.8% for Energa). Rising

energy prices, regulatory support for Generation (operational and cold

reserve mechanisms), as well as the regulated business in Distribution,

Heat and RES should improve visibility on earnings and thus also

dividends. We select two BUYs in the sector – Energa (we initiate

coverage and it is our top pick) and Enea (upgrade from Sell) – and

rate NEUTRAL both PGE and Tauron (latter upgraded from Sell).

Rising energy prices, support mechanisms and improving macro

With YTD increases in energy prices, support mechanisms launched by the

national operator (operational reserve in 2014E, cold reserve to be launched in

2016E), as well as the outlook for improving macro (GDP growth expected to

accelerate to 3.3% in 2015E and 3.6% in 2016E, based on Bloomberg consensus

estimates), results in a stable earnings outlook for the PL Utilities sector. While the

2013-16E EBITDA CAGR at the sector level is currently zero, we highlight that

BUY-rated Energa and Enea offer healthy 5.4% and 3.9% growth rates,

respectively. Almost half of our 2015E EBITDA forecast for the sector should come

from the regulated Distribution business, which together with regulated RES and

Heat contribution should improve earnings visibility for the sector.

Valuations still remain reasonable, given attractive dividends

Following the YTD sector rally (WIG Energy up 35% YTD, 30pps outperformance

vs. WIG), the sector is currently trading at a median 2015E EV/EBITDA of 6.5x, still

a 15% discount to European peers, but already above its LT average. Therefore we

would play the sector selectively, with a preference for improving earnings

outlook & healthy dividend payment capacity. Based on our forecasts, Energa

looks the most attractive on these criteria.

Implications of the recent EU summit

We highlight two important conclusions from the recent EU summit, discussed in

more detail on p7-8. Direct implications (i.e. expected ca. 417m free CO2 emission

rights or cash equivalents for energy sector in 2021-30E) should be viewed

positively, with Tauron potentially the key beneficiary. On the other hand, more

stringent EU targets on CO2 emission reduction in the LT might drive CO2 rights’

prices to levels well above the current EUR 6.4 and thus create a material cost

burden for the ‘dirty’-generation-oriented PL energy sector in the LT (Tauron

potentially most exposed).

Two BUYs (Energa and Enea) and two NEUTRALs (PGE, Tauron)

In this note we initiate coverage on Energa with a BUY rating (FV PLN 28.55,

14% upside), and select it as our top pick due to offering the strongest DY and

3-year EBITDA CAGR. We upgrade Enea to BUY from Sell (FV PLN 18.25, 14%

upside potential). Both PGE (new FV PLN 20.80) and Tauron (new FV

PLN 5.00) are rated NEUTRAL (reiterated for PGE, upgrade from Sell for TPE),

with FVs offering 6% and 5% downside potential, respectively.

This report formally transfers cover of ENA PW, PGE PW and TPE PW to Maria

Mickiewicz.

Energa

BUY 14% upside

Fair Value PLN 28.55

Bloomberg ticker ENG PW

Share Price PLN 25.03

Market Capitalisation PLN 10,364.10m

Free Float 48%

ENEA

BUY 14% upside


Bloomberg ticker ENA PW



Free Float 49%

PGE

NEUTRAL 6% downside


Bloomberg ticker PGE PW



Free Float 42%

Tauron

NEUTRAL 5% downside

Fair Value PLN 5.00

Bloomberg ticker TPE PW



Free Float 60%

All share price data as at close on 31-Oct-2014

Source: BESI Research, Company Data, Bloomberg

Analysts Maria Mickiewicz +48 22 347 4045 [email protected] Banco Espírito Santo de Investimento, S.A. – Warsaw Branch Poland 59 Zlota Street, 00-120 Warsaw

Page 2 of 57

Table of Contents Investment summary ......................................................................................................................................................................................................................... 3

Environmental policy framework until 2030 - implications for PL Utilities ...............................................................................................................9

Key sector drivers .............................................................................................................................................................................................................................. 11

Key sector risks .................................................................................................................................................................................................................................. 16

3Q14E Results Preview ................................................................................................................................................................................................................... 18

Valuations Summary ........................................................................................................................................................................................................................ 19

Assumptions & Forecasts Summary ........................................................................................................................................................................................ 22

Energa .................................................................................................................................................................................................................................................... 31

Enea ....................................................................................................................................................................................................................................................... 36

PGE .......................................................................................................................................................................................................................................................... 41

Tauron ................................................................................................................................................................................................................................................... 47

Valuation Methodology ................................................................................................................................................................................................................. 53

Risks to Fair Value ........................................................................................................................................................................................................................... 53

Page 3 of 57

Investment summary

Valuations & recommendations summary: ENERGA is our top pick

In this report we initiate coverage on Energa with a BUY recommendation and

FV of PLN 28.55, offering a decent 14% upside potential. Given its attractive

dividend outlook in the coming years, we select Energa as our top pick in the

sector. We upgrade Enea to BUY (from Sell) following an upward revision of

our FV to PLN 18.25, which offers 14% upside potential. We remain NEUTRAL

on PGE, believing that the recent positives have been already priced in. Our

new FV of PLN 20.80 currently offers 6% downside potential. We upgrade

Tauron to NEUTRAL (from Sell), having revised upwards our FV to PLN 5.00

(5% downside potential).

Table 1 PL Utilities: Valuations & recommendations summary

Company Ticker Price (PLN) Rating FV (PLN) Upside Rating FV (PLN)

New New potential (%) Old Old

Energa ENG PW 25.03 BUY 28.55 14% - -

Enea ENA PW 16.00 BUY 18.25 14% SELL 12.00

PGE PGE PW 22.10 NEUTRAL 20.80 -6% NEUTRAL 15.70

Tauron TPE PW 5.26 NEUTRAL 5.00 -5% SELL 3.70

Source: BESI Research for estimates, Company Data

Table 2 PL UTILITIES: SOTP Valuations Summary

ENERGA ENEA PGE TAURON

Asset Per shr % of EV Asset Per shr % of EV Asset Per shr % of EV Asset Per shr % of EV

(PLN m) (PLN) (%) (PLN m) (PLN) (%) (PLN m) (PLN) (%) (PLN m) (PLN) (%)

Distribution 10,126.0 24.5 67% 5,913.2 13.4 71% 13,993.7 7.5 33% 13,713.2 7.8 83%

Sales & Trading 2,026.1 4.9 13% 1,454.4 3.3 17% 5,032.2 2.7 12% 5,195.6 3.0 31%

Generation - CHP 360.6 0.9 2% - - - - - - 1,453.2 0.8 9%

Generation - RES 3,086.6 7.5 20% - - - 5,291.7 2.8 13% 1,408.3 0.8 8%

Generation - conventional 31.0 0.1 0% 1,750.3 4.0 21% 16,685.3 8.9 40% -5,873.5 -3.4 -35%

Mining - - - - - - - - - 1,212.1 0.7 7%

Other -466.0 -1.1 -3% -771.1 -1.7 -9% 1,008.0 0.5 2% -499.8 -0.3 -3%

Enterprise Value 15,164.2 36.6 100% 8,367.7 19.0 100% 42,011.0 22.5 100% 16,609.1 9.5 100%

Net Debt 3,337.5 8.1 -775.4 -1.8 -1,403.5 -0.8 5,796.2 3.3

Minorities & Associates 13.8 0.0 16.0 0.0 257.3 0.1 -44.4 0.0

Net debt equivalent provisions 993.6 2.4 1,598.4 3.6 6,897.3 3.7 2,761.6 1.6

Equity Value (1 Jan 2014) 10,819.3 26.1 7,507.8 17.0 36,259.9 19.4 8,095.7 4.6

Shares (m) 414.1 441.4 1,869.8 1,752.5

FV 28.55 18.25 20.80 5.00

Rating BUY BUY NEUTRAL NEUTRAL


We note that our valuations continue to be fully based on SOTP valuations

(each segment valued separately based on a DCF model). For illustrative

purposes we have also conducted peer comparisons to Polish and European

peers and present below multiple-implied valuations (though a zero weighting

is attached when calculating FVs), which would imply: PLN 27.9 for Energa,

PLN 18.6 for Enea, PLN 22.7 for PGE and PLN 8.3 for Tauron. We note that PL

Utilities are currently trading at a 15% discount to European peers on 2015E

EV/EBITDA Bloomberg consensus estimates.

Page 4 of 57

Table 3 PL Utilities: Peer comparison to European peers

Last Price FV Mcap P/E (x) EV/ EBITDA (x) 1Y fwd

Ticker Rating (LCU) (LCU) (EUR m) 2014E 2015E 2016E 2014E 2015E 2016E DY%

PLN PGE PGE PW NEUTRAL 22.10 20.80 9,781 11.2x 13.5x 13.6x 5.3x 6.5x 6.9x 4.5%

PLN Tauron TPE PW NEUTRAL 5.26 5.00 2,182 7.7x 8.2x 9.0x 4.5x 5.0x 5.5x 3.2%

PLN Enea ENA PW BUY 16.00 18.25 1,672 9.2x 12.7x 11.1x 4.7x 6.5x 6.5x 3.8%

PLN Energa ENG PW BUY 25.03 28.55 2,453 10.5x 10.7x 11.8x 6.1x 6.1x 6.4x 4.8%

Median - PL Utilities 10.5x 12.7x 11.8x 5.3x 6.5x 6.5x 4.5%

EUR EDF EDF FP Not Covered 22.9 - 43,803 10.9x 10.4x 10.0x 5.0x 5.0x 4.8x 5.3%

EUR GdF SUEZ GSZ FP Not Covered 18.9 - 46,700 14.7x 13.5x 12.9x 6.8x 6.4x 6.4x 5.2%

EUR E.ON AG EOAN GR Not Covered 13.7 - 27,334 15.6x 15.4x 15.4x 5.6x 5.6x 5.4x 3.8%

EUR ENEL SPA ENEL IM Not Covered 3.9 - 38,272 12.7x 12.0x 11.3x 6.1x 6.0x 5.9x 3.2%

EUR RWE AG RWE GR Not Covered 28.2 - 17,036 12.2x 12.5x 13.1x 4.9x 4.6x 4.4x 3.5%

EUR IBERDROLA SA IBE SM BUY 5.5 6.2 35,579 15.8x 15.3x 14.5x 9.0x 8.7x 8.4x 4.8%

EUR ENDESA SA ELE SM NEUTRAL 15.2 30.0 16,448 9.8x 15.7x 13.9x 4.6x 8.9x 8.3x 45.7%

GBp CENTRICA PLC CNA LN Not Covered 300 - 19,249 14.2x 12.8x 12.2x 6.1x 5.6x 5.4x 5.8%

EUR FORTUM OYJ FUM1V FH Not Covered 18.0 - 16,426 16.1x 17.0x 17.1x 11.1x 11.9x 11.9x 5.8%

GBp SCOTT. & SOUTH. ENERGY SSE LN Not Covered 1,581 - 20,200 13.1x 13.4x 13.1x 10.3x 10.7x 10.2x 5.6%

EUR EDP SA EDP PL BUY 3.3 3.35 12,546 13.5x 13.4x 12.4x 9.3x 8.9x 8.2x 5.5%

EUR VERBUND VAR AV Not Covered 15.9 - 5,602 16.6x 14.1x 11.8x 13.0x 12.1x 11.4x 1.6%

Median - European Utilities 13.8x 13.5x 13.0x 6.4x 7.6x 7.3x 5.3%

PL Utilities vs. European peers -24% -6% -9% -17% -15% -10%

Source: BESI Research estimates for covered stocks, Bloomberg consensus estimates for not rated stocks, Company Data

Table 4 PL Utilities: Multiple-implied valuation (for illustrative purposes only)

(PLN m) P/E (x) EV/ EBITDA (x)

Weight Average 2014E 2015E 2016E 2014E 2015E 2016E

ENERGA vs. PL peers 50% 25.6 25.0 29.7 25.0 21.1 26.9 25.5

vs. European peers 50% 30.3 32.9 31.5 27.5 27.1 33.2 29.7

Weighted average 27.9

ENEA vs. PL peers 50% 16.9 18.3 16.0 17.1 18.3 15.9 16.0



PGE vs. PL peers 50% 20.9 20.8 20.9 19.2 22.1 22.1 20.4



TAURON vs. PL peers 50% 7.5 7.1 8.1 6.9 6.9 8.3 7.5




Still some room for growth for selected picks despite strong YTD

performances

Figure 1 PL Utilities: Sector relative YTD performance vs. market (WIG)

and foreign peers (Stoxx600 Utilities) - all rebased to 100 Figure 2 PL Utilities: Selected stocks' performance YTD

Source: BESI Research, Bloomberg Source: BESI Research, Bloomberg

70

80

90

100

110

120

130

140

150

STOXX600 Utilities WIG Energia WIG

63%

38%35%

23% 22%

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Energa PGE WIG Energy Tauron Enea

Page 5 of 57

The PL Utilities sector has rallied YTD, delivering a total return of 35%,

materially outperforming both its foreign peers (measured by Stoxx600

Utilities index – up by 14% YTD) and the broad Polish market (measured by

the WIG index, up a mere 5% YTD). Energa and PGE were the strongest

performers (+63% and +38%, respectively).

We believe, however, that even after such a rally there is still some upside

potential in the sector – which we would recommend playing via Energa and

Enea – pointing to two key issues: (1) strong PL Utilities sector performance

observed YTD follows a weak performance in 2013, when the sector was down

10%, underperforming its foreign peers and the broad Polish market by ca. 15-

17pps; (2) the sector rally was accompanied by an improving earnings outlook

in the whole sector, driving upward revisions of consensus estimates for all

four stocks, which resulted in only a moderate sector re-rating and left

valuations at reasonable levels (median 2015E EV/EBITDA for PL Utilities

sector at 6.5x, still a 15% discount to European peers), though above LT

averages on the current year EV/EBITDA (therefore we would play the sector

only selectively).

Figure 3 ENERGA: 2014E EBITDA consensus revisions Figure 4 ENEA: 2014E EBITDA consensus revisions

Source: Bloomberg consensus Source: Bloomberg consensus

Figure 5 PGE: 2014E EBITDA consensus revisions Figure 6 TAURON: 2014E EBITDA consensus revisions


1,800

1,900

2,000

2,100

2,200

2,300

2,400

14

16

18

20

22

24

26

Energa share price (PLN, LHS) 2014E EBITDA (PLN m, RHS)

1,350

1,450

1,550

1,650

1,750

1,850

12

13

14

15

16

17

Enea share price (PLN, LHS) 2014E EBITDA (PLN m, RHS)

6,400

6,700

7,000

7,300

7,600

7,900

14

16

18

20

22

24

PGE share price (PLN, LHS) 2014E EBITDA (PLN m, RHS)

3,100

3,200

3,300

3,400

3,500

3,600

3.8

4.2

4.6

5

5.4

5.8

Tauron share price (PLN, LHS) 2014E EBITDA (PLN m, RHS)

Page 6 of 57

Figure 7 PL Utilities: Historical current year sector EV/EBITDA (x) Figure 8 PL Utilities: Historical current year sector P/E (x)


Stock picking – BUY Energa and Enea

Energa (BUY, FV PLN 28.55): We initiate coverage on Energa with a BUY

recommendation and FV of PLN 28.55, offering 14% upside potential. Energa is

our top pick in the sector, due to: (1) strong dividend offered in 2015E (DY of

almost 5%); (2) good earnings visibility (substantial exposure to regulated

businesses, accounting for almost 90% of our 2015E EBITDA forecast),

supportive for dividends in the coming years; (3) healthy cash flow generation

due to lack of heavy capex pipeline in Generation segment; and (4) preferred

production mix, most skewed to RES within our PL Utilities universe, limiting

exposure to more restrictive EU environmental regulations in the LT.

Enea (BUY, FV PLN 18.25): We are upgrading Enea to BUY (from Sell), having

increased our FV to PLN 18.25, which offers 14% upside potential. While 2015E

may bring a slight 3% YoY EBITDA contraction, following huge positive one-

off boosting the 2014E figure (PLN 258m LTC compensations), we expect a

healthy earnings recovery starting from 2016E (2013-16E EBITDA CAGR at

3.9%). Results should be supported by the first ever cost optimization

programme at Enea (management initially targeted PLN 0.5bn in 2014-16E,

but we believe there might be higher cost-cutting potential) and a positive

impact from assumed wind farm acquisitions starting from 2016E (in line with

Enea’s LT strategy). Moreover, we note that Enea should be the first amongst

PL Utilities to benefit from launching new large capacities (1,075 MW

Kozienice project to be completed mid-2017E). Potential acquisitions in the

regulated business segments - Heat (not included in our model) and greater

than assumed scale of M&A in RES - could be potential triggers.

PGE (NEUTRAL, FV PLN 20.80): We reiterate our NEUTRAL recommendation

on PGE. Our new FV of PLN 20.80 implies currently 6% downside potential,

following a strong YTD rally (+38%, 33pps outperformance vs. WIG). While

PGE offers a healthy balance sheet and highest exposure amongst PL Utilities

to rising energy prices, being the only one long in Generation, we believe the

positives have been already priced in and fully reflected in its demanding

valuation. The stock is trading at 2015-16E EV/EBITDA of 6.5x and 6.9x, in line

for 2015E, but at a 6% premium to its Polish peers for 2016E, not justified in

our view in the LT due to PGE’s potentially more volatile earnings profile

compared to peers (highest earnings exposure to Generation). While 2014E

EBITDA should be heavily boosted by one-offs in Generation (net positive

impact of PLN 1.6bn expected), 2014-15E earnings should still see YoY declines

and only a slight recovery in 2016E. This should result in a negative 2013-16E

EBITDA CAGR of –2.6%. Together with declining earnings and having assumed

maintenance of a 50% payout, we expect DPS to contract to PLN 0.99 in

2015E and PLN 0.82 in 2016E (DY of 4.5% and 3.7%, respectively).

2.8

3.0

3.2

3.4

3.6

3.8

4.0

4.2

4.4

4.6

4.8

5.0

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

6

7

8

9

10

11

12

13

14

15

Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14

Page 7 of 57

Tauron (NEUTRAL, FV PLN 5.00): We upgrade Tauron to NEUTRAL from Sell,

following upward revision of forecasts (to account for support mechanisms in

Generation, higher energy prices, but lower profitability in Sales),

implementation of a lower RFR and thus an FV increase. Our new FV of PLN

5.00 (up from PLN 3.7) offers 5% downside potential. While the company is

the most leveraged of the PL Utilities, and still has huge capex outlays ahead

(almost PLN 29bn through 2020E), we believe Tauron should be able to

maintain its reduced dividend payout ratio of 25% at least in 2015E (DY of

3.2%). LT dividend payment capacity should depend on the company’s ability

to de-leverage by using investment vehicles and via planned disposals of

majority stakes in wind farms. We forecast stable EBITDA through 2016E (3-yr

CAGR at -0.3%), supported materially by the operational reserve.

Forecasts overview vs. Bloomberg consensus estimates

At the EBITDA level, we are slightly above market expectations (Bloomberg)

for Energa and Enea for 2016E only, but visibly above consensus on the

bottom line. We believe this is mainly related to the lower net financial costs

burden assumed by us (incorporating the recent interest rate decline, most

probably not fully revised yet in market consensus estimates) and also lower

D&A expected by us for Enea starting from this year (related to revision of

Kozienice amortization, already visible in 2Q14 figures).

For PGE and Tauron, our EBITDA forecasts are in line (or slightly below) with

market consensus estimates. On the bottom line, we are visibly above market

expectations for Tauron for 2015-16E, which we would explain by the lower net

financial costs assumptions (change in interest rate impacts the bottom line

materially due to Tauron’s already huge debt). For PGE, we are slightly below

consensus for 2014E and 2016E (more materially for 2015E where we are also

3% below at the EBITDA level), given our expectations of a materially rising

net debt position, driven by spending on the Opole and Turów projects,

expected by us to peak in 2015-16E (while PGE was still materially net cash

positive after 1H14).

Table 5 PL Utilities: BESI Research forecasts vs. Bloomberg consensus estimates (PLN m)

Bloomberg BESI

NI

EBITDA NI

EBITDA

Company 2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E 2014E 2015E 2016E

Energa 911 872 782 2,269 2,290 2,230 985 968 877 2,268 2,321 2,304

vs consensus (%) 8% 11% 12% 0% 1% 3%

Enea 657 525 520 1,672 1,642 1,811 767 555 639 1,679 1,624 1,870

vs consensus (%) 17% 6% 23% 0% -1% 3%

PGE 3,727 3,408 3,154 7,596 7,360 7,436 3,697 3,070 3,034 7,574 7,166 7,413

vs consensus (%) -1% -10% -4% 0% -3% 0%

Tauron 1,165 1,041 908 3,574 3,590 3,623 1,190 1,121 1,029 3,548 3,592 3,631

vs consensus (%) 2% 8% 13% -1% 0% 0%

Source: BESI Research estimates, Bloomberg consensus estimates

High valuation sensitivity to RFR (10Y government bond yield) changes

We note that valuations of PL Utilities are highly sensitive to changes in RFR

(10-year government bond yields) assumptions and the recent material

declines in yields (from ca. 3.8% at the beginning of the year) have given a

material boost to valuations in the sector. In our model we currently use a RFR

of 3.21% (based on a 3-month average), but note that a further decline in the

RFR (while most recent readings of bond yields are well below our

assumptions) should be supportive for sector valuations.

A decline in the RFR utilized in the WACC calculation by 0.2pps, ceteris

paribus, would drive our FV for Tauron up the most (+13%), while for the

remaining players (Enea, PGE and Energa) they would rise by ca. 6-8%. Please

note, however, that this exercise (as presented in the table below) only

measures sensitivity of our FVs to DCF WACC changes, triggered by RFR

Page 8 of 57

changes, while the declining RFR should also result in a potentially lower

WACC for the Distribution segment in 2016E+ (lowering the regulated EBIT

and thus also valuation of the segment, ceteris paribus), which should partially

limit the net positive impact on the valuations.

Table 6 PL Utilities: FV sensitivity to changes in RFR (10-yr government bond yields) assumption (PLN)

4.01% 3.81% 3.61% 3.41% 3.21% 3.01% 2.81% 2.61% 2.41%

Energa 22.63 23.97 25.40 26.92 28.55 30.30 32.17 34.20 36.39

vs. FV -21% -16% -11% -6% 0% 6% 13% 20% 27%

Enea 13.38 14.47 15.64 16.90 18.25 19.70 21.27 22.97 24.81

vs. FV -27% -21% -14% -7% 0% 8% 17% 26% 36%

PGE 16.71 17.63 18.62 19.67 20.80 22.02 23.32 24.74 26.27

vs. FV -20% -15% -11% -5% 0% 6% 12% 19% 26%

Tauron 2.88 3.35 3.86 4.41 5.00 5.63 6.31 7.04 7.84

vs. FV -42% -33% -23% -12% 0% 13% 26% 41% 57%

Source: BESI Research for estimates

Page 9 of 57

Environmental policy framework until 2030 - implications for PL

Utilities

On 23-24 October, during the EU environmental summit in Brussels, member

countries agreed on a 2030 environmental policy framework. Key areas of the

agreement include:

Binding target for reduction of greenhouse gas emissions by 40% (vs.

1990 levels) until 2030 – target set on each member country level.

Binding target of at least 27% share of RES in energy consumption in

2030 – target set on the whole EU level (not each country level).

EU agreed on at least a 27% increase in energy efficiency through

2030 (non-binding target) – less than the initially planned 30% and

therefore the target should be re-considered in 2020 (with an option

of increasing it to 30%).

Less affluent EU member countries (with GDP per capita below 60%

of the EU average), including Poland, will be allowed to continue

granting their energy sectors free CO2 emission rights until 2030 (cap

set at 40% of the allocation for auction).

Countries with GDP per capita below 90% of the EU average will

obtain 10% of total emission rights allocation.

New special reserve will be created, amounting to 2% of total CO2

emission rights allocation (cash equivalent) – to be used by less

affluent countries (with GDP per capita below 60% of the EU average,

thus including Poland) for energy sector modernization. EIB is to be

involved in the management of the reserve funds.

The most important implications of the EU summit for PL Utilities sector

would, in our view, be as follows:

In 2021-30, the PL energy sector should be granted ca. 282m free

CO2 emission rights (40% out of 706m emission rights, calculated

based on historical emissions), as well as cash equivalent to ca. 135m

rights (based on wnp.pl, quoting information from the Environment

Ministry), which gives a total amount equivalent to ca. 417m rights (vs.

404m free rights granted to the PL energy sector for 2013-20) as

potential support for the sector.

Criteria for allocation of free emission rights for the sector have not

been set yet, though it is said these should not be granted

unconditionally (in 2013-20, the PL energy sector should obtain a

total 404m free emission rights under the condition of executing

investment projects agreed on within the National Investment Plan).

Given all the above, we see the following potential implications for the sector:

Based on the assumption that in 2021-30 the PL energy sector

obtains a total of 417m free emission rights & cash equivalents, as well

as assuming the same proportional participation of specific energy

groups as in the 2013-20 allocation (no visibility at this stage, though,

how it might be distributed), we estimate that PGE should receive in

total ca. 158m allowances & cash equivalents, Tauron 71m, Enea 30m

and Energa only 11m (see the table below).

Table 7 PL Utilities: Potential distribution of free CO2 allowances & cash equivalents in 2021-30 (one of possible scenarios, assuming the same

proportional distribution as in 2013-20)

2021-30 2013-20

(m) Free CO2 allowances Cash equivalent Total Free CO2 allowances as % of total

PGE 107 51 158 153 38%

Tauron 48 23 71 68 17%

Enea 20 10 30 29 7%

Energa 7 3 11 10 3%

Other 100 48 148 144 36%

Total for Poland 282 135 417 404


Page 10 of 57

Based on the assumed distribution, as in the table above, ceteris

paribus, Tauron should be the key beneficiary in relative terms

(impact on valuation), followed by PGE, Enea and Energa. At current

CO2 emission right prices (EUR 6.42), it could imply respective upside

potential to our FVs of 12% for Tauron, 6% for PGE, 5% for Enea and a

mere 1% for Energa. In the table below, we present a scenario analysis

with potential upside for all four companies (post-tax discounted

figures, assuming the total grant for the company is equally annually

distributed in years 2021-30) and sensitivity to potential increases in

the CO2 emission rights price.

Table 8 PL Utilities: Scenario analysis of potential upside resulting from free CO2 emission rights to be obtained in 2021-30, depending on CO2

rights price

CO2 @ EUR 6.42 CO2 @ EUR 10.00 CO2 @ EUR 15.00 CO2 @ EUR 20.00

Post tax discounted Per shr Upside Post tax discounted Per shr Upside Post tax discounted Per shr Upside Post tax discounted Per shr Upside

Company (PLN m) (PLN) to FV (PLN m) (PLN) to FV (PLN m) (PLN) to FV (PLN m) (PLN) to FV

PGE 2,350 1.26 6% 5,579 2.98 15% 8,368 4.48 22% 11,158 5.97 30%

Tauron 1,060 0.60 12% 2,517 1.44 29% 3,775 2.15 43% 5,033 2.87 57%

Enea 442 1.00 5% 1,050 2.38 13% 1,574 3.57 19% 2,099 4.76 26%

Energa 162 0.39 1% 384 0.93 3% 576 1.39 5% 768 1.85 6%


We note that the increased targets for the reduction of greenhouse

gas emissions until 2030 and EU priorities related to protecting the

environment may result in rising CO2 emission rights prices after

2020. The impact on the PL Utilities sector (huge coal-generation

exposure, thus high CO2 intensity ratio) of potentially higher CO2

costs burden after 2020E should depend on the ability to fully pass

on higher CO2 costs to clients via higher energy prices. In the table

below we present PL Utilities’ high CO2 costs burden (key risk, given

EU long-term targets aimed at reducing CO2 emissions) and their

valuations’ exposure to rising CO2 emission rights prices, assuming

higher costs are not passed on via higher energy prices at all

(theoretical worst case scenario; these calculations do not take into

account free emission rights allocation). In that case, Tauron would

potentially be the most affected, followed by Enea and PGE, while the

negative impact on Energa (with by far the highest exposure to RES

amongst the PL Utilities) should be very limited.

Table 9 Additional cost (post-tax) due to CO2 emission right price increase vs. currently assumed in our model EUR 6.84 in 2021E+ (worst case

scenario - i.e. no additional cost passed on the client via a higher energy price)

CO2 @ EUR 10.00 CO2 @ EUR 15.00 CO2 @ EUR 20.00

Additional cost Per share Additional cost Per share Additional cost Per share

(PLN m) (PLN) (PLN m) (PLN) (PLN m) (PLN)

PGE 9,484 5.07 24,489 13.10 39,495 21.12

Tauron 3,323 1.90 8,580 4.90 13,837 7.90

Enea 2,232 5.06 5,763 13.06 9,294 21.05

Energa 439 1.06 1,132 2.73 1,826 4.41


We note that following the announcement of EU summit conclusions on

Friday, 24 October, the market reacted positively, but in the end only PGE

closed that day with a material share price increase (+3.6%), while Enea and

Tauron closed flat and Energa rose by a mere 1%. Regarding PGE’s share price

increase, we believe that the market priced in mainly the upside potential

related to the expected obtaining of free CO2 emission rights for 2021-20,

while neglecting potential risks of the rising cost burden in the LT. While

visibility on the issue still remains very low, we believe that potential positives

related to additional free allowances and potential negatives resulting from at

least partial consumption of higher costs burden in the LT (not to be fully

passed onto clients, in our view) may more or less offset each other and

therefore at this stage none of them is included in our forecasts / valuations.

Page 11 of 57

Key sector drivers

Rising energy prices supportive for mid-term earnings outlook

Energy prices in Poland started to bottom out in the middle of last year, and

were helped this year by newly launched support mechanisms (operational

reserve), which provide a healthy support for the mid-term results outlook in

the sector. We note that Polish energy prices currently trade at a premium to

German energy prices, which we believe should be sustainable at least in short

to mid-term thanks to support mechanisms (operational reserve expected to

remain in the market until 2016E, while in 2016-19E an addition cold reserve

mechanism should be launched).

Figure 9 Poland: Energy prices (baseload) Figure 10 Poland vs. Germany: 1-year forward baseload prices (PLN)

Source: BESI Research, Bloomberg Source: BESI Research, Bloomberg

Reasonable macro outlook and expected rising electricity production

Accelerating Polish GDP growth in 2014E-16E (expected at 3.1%, 3.3% and

3.6%, respectively, based on Bloomberg consensus estimates) should be

supportive for growth in demand for electricity. In terms of industrial drivers

for electricity consumption, we note that after a weak August, both Polish

Manufacturing PMI and industrial output YoY growth bottomed out in

September. It was followed by a strong PMI reading in October, which jumped

to 51.2pts (from 49.5pts) reaching its highest level since April 2014. The

increase in production and employment were the main drivers while exports

dynamics remained in the red but the decline is slowing. Inventories visibly

dropped which may point to a further increase in production in the following

months. Industrial output increased in September by a healthy 4.2% YoY, after

rather weak readings in June-August.

Figure 11 Poland GDP YoY growth expected to accelerate in 2014-16E

(%)

Figure 12 Poland PMI Manufacturing and Industrial output growth YoY

(historical monthly data)

Source: Bloomberg Source: Bloomberg

100

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spot 1YR forward 2YR forward

1YR fwd = 2012 2YR = 2013

1YR fwd = 2013 2YR = 2014

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-14

Poland 1YR fwd baseload Germany 1YR fwd baseload

6.8

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2007 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E

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PMI Manufacturing (LHS) Industrial output growth YoY (RHS, %)

Page 12 of 57

According to the draft of Poland’s Energy Policy until 2050 published on 14

August 2014 by the Ministry of Economy, Polish energy production should rise

to 158.8 TWh in 2015E, and then further to 206.8 TWh in 2030E and 222.9

TWh in 2050E – implying growth at a 2015-30E CAGR rate of 1.8% and then a

2030-50E CAGR of 1.0%.

Below we present the detailed forecasts presented in the draft of the energy

policy until 2050, showing that hard coal & lignite should remain key energy

sources until 2030E, but their share should fall from 82% in 2015E to 57% in

2030E and a mere 38% in 2050E. RES contribution should rise from 13% in

2015E to 25% in 2030E and 33% in 2050E. The projections assume a ca. 20%

contribution from nuclear energy starting from 2035E (first contribution of 6%

expected in 2025E, which however in our opinion might be a challenge).

Figure 13 Polish energy production forecast until 2050E, TWh (based on

draft of Polish Energy Policy until 2050)

Figure 14 Polish energy production mix forecast until 2050 (based on

draft of Polish Energy Policy until 2050)

Source: BESI Research, Ministry of Economy - draft of Poland’s Energy Policy until 2050 Source: BESI Research, Ministry of Economy - draft of Poland’s Energy Policy until 2050

Low interest rates environment favors dividend plays

We believe that in the environment of declining interest rates, the preference

for high-yielding dividend plays amongst investors should rise. Attractive

dividend yields offered by PL Utilities sector should be one of the major sector

drivers in the short and mid-term perspective, in our view. Based on our

expectations, Energa offers the highest 2015E DY of 4.8% and in our opinion

also the highest visibility for dividend growth potential in the coming years.

PGE should offer a 2015E DY of 4.5%, supportive for the stock in the ST, but

we see a risk of lower dividends in the coming years. Enea and Tauron should

offer lower dividends, but forecast 2015E DYs of 3.8% and 3.2%, respectively,

still look reasonable (we highlight, however, that we see some risks related to

the sustainability of Tauron´s dividend policy in the coming years).

157.7 158.8177.9

187.5206.8

221.4 229.7 229.5 222.9

0

50

100

150

200

250

2010 2015E 2020E 2025E 2030E 2035E 2040E 2045E 2050E

Hard coal Lignite Gas RES Nuclear Other Total

56%46% 43% 40% 38% 38% 39% 36% 33%

31%37%

30%26%

18%5% 5% 5% 5%

4%4%

7%6%

6%

8% 8% 10% 9%

7% 13% 19%20%

25%

28% 28% 29% 33%

6% 11%20% 20% 19% 19%

0%

10%

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30%

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50%

60%

70%

80%

90%

100%

2010 2015E 2020E 2025E 2030E 2035E 2040E 2045E 2050E

Hard coal Lignite Gas RES Nuclear Other

Page 13 of 57

Figure 15 PL Utilities: Dividend yields in 2014 and expected until 2017E


Positive surprises delivered in cost efficiency programs

Cost–cutting programs, focused primarily on employment right-sizing (VLP,

etc.), were and continue to be one of the important drivers for earnings

growth for the PL Utilities sector. We note that all the companies apart from

Enea have already reduced their workforce by over 10% since 2009, resulting

in material savings.

We note that Enea has launched its first-ever cost optimization program this

year. Management initially planned to save a total of PLN 0.5bn in 2014-16E

(PLN 0.1bn in 2014E and PLN 0.2bn annually in both 2015E and 2016E), though

we see room for greater savings already in the first year, creating in our

opinion upside potential to the PLN 0.5bn management guidance through

2016E. Given this is the first-ever cost-cutting program, we believe targets

should be relatively more easily achievable than for its peers. As for the

remaining companies: (1) PGE targets cost efficiencies to result in an

additional ca. PLN 1bn savings after 2016E vs. the 2013 level (we assume in our

model this level of savings to be reached only two years later); (2) Tauron

targeted PLN 860m total savings in 2013-15E, but already in the first year of

2013, the company managed to deliver savings of PLN 320m, indicating in our

opinion potential for much higher total savings (assumed in our model at

PLN 1.1bn – PLN 385m in 2014E and PLN 425m in 2015E); (3) as we see Energa

as already the most cost efficient play, cost reductions should be in our

opinion the least significant for Energa – a mere ca. 2% annual contribution to

the EBITDA level in 2014-15E.

Support mechanisms in Generation – operational and cold reserves

Two support mechanisms for PL Utilities sector have been launched by the Polish

operator – an operational reserve launched this year (which improves profitability

of on-line units) and cold reserve to be launched in 2016E (support for old plants

that might be required at peak times) – and should be supportive for the sector

earnings in the coming years (we assume the operational reserve through 2016E

and cold reserve through 2019E). All four companies are already benefiting from

the operational reserve mechanism (with Tauron being the key beneficiary both in

absolute terms as well as in terms of % support to annual EBITDA). As far as the

cold reserve is concerned, so far there have been two tenders – one won by

Tauron and the other by PGE.

4.0

%

4.8

%

5.0

%

5.0

%

3.6

%

3.8

%

2.8

% 3.2

%

5.0

%

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%

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%

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%

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%

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%

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%

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%

0%

1%

2%

3%

4%

5%

6%

2014 2015E 2016E 2017E

Energa Enea PGE Tauron

Page 14 of 57

Figure 16 PL Utilities: Assumed total positive impact of operational and

cold reserve mechanisms on 2014-19E EBITDA forecasts (PLN m)

Figure 17 PL Utilities: Operational and cold reserve mechanisms

percentage contribution to 2014-19E EBITDA forecasts (%)

Source: BESI Research for estimates Source: BESI Research for estimates

Introduction of a full-scale capacity market that the sector is lobbying for

could be a potential LT driver

The PL energy sector is lobbying for the introduction of a full scale capacity

market, but in our view this might be a potential trigger for the sector only in

the LT. According to Mr. Jacek Kaminski, professor from the Energy Institute

of PAN, the already implemented mechanisms of the operational or cold

reserve (which we view as some elements of the capacity market) should

secure the required level of capacities in the market in the medium term, as

quoted by wnp.pl. However, in the LT the full scale capacity market should

secure the required and administratively decided level of generation

capacities, as well as create long-term incentives for investments in new

capacities.

Potential M&A in the sector

While PGE and Tauron were listed as strategic companies for the country

(presented by the government information centre, CIR, in August 2014),

Energa and Enea were listed amongst the 190 companies that might undergo

ownership changes and thus we would view them as potential acquisition

targets. We note that recently CEZ named Energa as one of its considerations

as a potential acquisition target in the region (CEO of CEZ quoted by

Bloomberg in September). On the chart below, we present the shareholder

structure for all four companies.

49 49 49

0 0 018 18 18

0 0 0

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250 250

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2014E 2015E 2016E 2017E 2018E 2019E


Page 15 of 57

Figure 18 PL Utilities – current shareholder structure

Source: BESI Research, Company Data

*Note: Structure in capital (State Treasury holds 64.09% stake in terms of votes)

In the table below we present PL Utilities’ exposure (in terms of volumes) to

Generation, Distribution and Retail Sales segments. PGE is a clear leader in

Generation (43% market share after 9M13), but only number two in

Distribution (where Tauron is a clear leader with a 39% market share).

Theoretically we could think of potentially value-adding transactions by PGE

in order to strengthen its position in Distribution. While theoretically Enea and

Energa could be considered as potential acquisition targets (offering

respective 14% and 16% market shares in Distribution, while only a limited 9%

and 4% in Generation), it is not clear to us at this stage whether UOKiK would

allow for such transactions, given PGE’s already high market share in

Generation.

Table 10 PL Utilities: Exposure to Generation, Distribution and Sales in terms of volumes (TWh)

Generation volume Market share* Position Distribution volume Market share* Position Retail sales volume Market share* Position

(TWh) (%) (#) (TWh) (%) (#) (TWh) (%) (#)

Energa 5.0 4% 4 20.4 16% 3 18.2 15% 3

Enea 11.9 9% 3 17.3 14% 4 13.2 11% 4

PGE 57.0 43% 1 31.8 26% 2 36.9 30% 2

Tauron 19.4 16% 2 47.9 39% 1 41.3 33% 1


*Note: Market share based on 9M13 volumes by ARE, as quoted by Energa in FY13 financial report

51.52% 51.50%58.39%

30.06%

10.39%5.06%

48.48% 48.50%41.61%

54.49%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Energa* Enea PGE Tauron

State Treasury KGHM ING Pension Fund Other

Page 16 of 57

Key sector risks

PL energy sector might be pressured to participate in solving the problem of

loss-making coal mines

If the scenario of the PL Utilities sector buying coal mines from Kompania

Weglowa materializes (though we note that none of the companies has

expressed any plans to do so), this might potentially involve material capex

and thus create potential downside risks towards dividends.

We note that in mid September there was lots of newsflow on the issue of

solving the problems of the troubled coal mines (according to PAP, only 3 out

of 14 Kompania Weglowa coal mines were profitable in 1H14). First, PAP

quoted Deputy Economy Minister Mr. Tomasz Tomczykiewicz as saying that

Poland wants PGE, Tauron and Enea to take over coal mines from Kompania

Weglowa as part of the repair plan for the mining company. The final

decisions should be made this year, the official reportedly noted. However,

soon after, vice-minister of the State Treasury, as quoted by the daily Parkiet,

stated that no analysis regarding the potential acquisition of KW’s mines by

energy utilities companies was being carried out and this is not considered

within the planned restructuring of KW. Also all above mentioned companies

(PGE, Tauron and Enea) deny being in talks / considering acquisition of KW’s

mines.

The first, more immediate part of the repair plan would involve state coal

exporter Weglokoks buying some of the Kompania Weglowa mines, the

official indicated. According to the most recent statements from the CEO of

Weglokoks, quoted by wnp.pl portal, Weglokoks is interested in buying 5 of

KW’s mines. A letter of intent has apparently already been signed. Valuation of

the assets to be acquired has not started yet, but the CEO of Weglokoks

expects the project to be completed by the end of the year.

The situation of the troubled KW still remains unsolved, so some risks for the

PL Utilities sector still persist, in our view.

Still lots of local regulatory uncertainty …

We highlight some uncertainty regarding the final shape and timing of

implementing changes in regulations / new law in RES (uncertainty regarding

timing and final shape of the new RES law, as well as financial implications of

the planned auctioning systems and settlement of reference price in auctions)

and Distribution (still limited visibility on remuneration system starting from

2016E and importance of quality measures, though at this stage we would

expect some evolution than revolution in this matter, thus only gradual

implementation of some quality measures; question mark on further room for

beating the costs benchmark – e.g. currently companies are benefiting from

lower costs for network losses than those passed through in regulated

revenues). Apart from the abovementioned expected regulatory changes, we

also note that unpredictable regulatory changes are a much bigger risk for the

regulated business and in this area the history for PL Utilities sector is not

supportive (with the most notable example being the disappearance of

support for co-generation last year and relaunching of the support in May

2014).

Rising burden from costs related to colour certificates and CO2 allowances

persists as one of the key risks for the PL Utilities sector in the LT

The relaunching of support for co-generation (i.e. requirement to redeem red

and yellow certificates) starting from May 2014, should impact 2014E (8-

month negative impact) and 2015E results (FY negative impact) negatively. In

coming years, we believe PL Utilities should be able to pass on the rising costs

burden related to certificates (required gradual % increase of specific energy

Page 17 of 57

types’ share in the sales mix) to their clients. If this is not the case, the Sales

segment profitability could come under further substantial downward

pressure starting from 2016E.

Table 11 PL Utilities: Rising requirement for colour certificates redemption (as % of sales volume to end-users)

2014 2015 2016 2017 2018 2019 2020 2021

Yellow certificates requirement (%) 3.9% 4.9% 6.0% 7.0% 8.0% 0.0% 0.0% 0.0%

Red certificates requirement (%) 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2% 23.2%

Green certificates requirement (%) 13.0% 14.0% 15.0% 16.0% 17.0% 18.0% 19.0% 20.0%

Purple certificates requirement (%) 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1% 1.1%


Figure 19 Green certificate price development (PLN) Figure 20 CO2 emission rights - forwards (EUR)

Source: Bloomberg Source: Bloomberg

In terms of CO2 allowances, the burden of CO2 costs should be rising through

2020E as free allowances allocation (from what was previously granted to PL

Utilities for years 2013-20) for PL Utilities should be approaching zero by then

– but this has already been known for a long time and we believe it is fully

priced in at current CO2 allowances prices (priced recently at EUR 6.4 and

2015E-17E forward contracts traded currently at EUR 6.5-6.8).

Following recent EU summit conclusions regarding CO2 emissions’ reduction

targets for the next period (2021-30E) and planned allocation of another pool

of free emission rights for Poland, we note that at this stage it is not clear

what the allocation for specific companies might be (we present more

detailed analysis of the issue on pages 7-8 of this report) and how it should be

allocated in specific years (equally or similar to the 2013-20 allocation – i.e.

largest number of free rights in the first years of the period, then falling to

reach zero in the last year - 2030). Nevertheless, no matter what allocation

scheme will be implemented, we see a material risk that higher emission

reduction targets agreed upon during the recent EU summit should result in a

higher cost burden for the ‘dirty’-generation-oriented PL energy sector in the

LT (after 2030E). We note that the scale of the cost burden for PL Utilities

(resulting from CO2 rights prices potentially rising in the LT) and thus the

impact on companies’ results and valuations would depend on companies’

ability to pass on to clients the rising costs in the LT.

Table 12 PL Utilities: Declining number of free CO2 emission rights within 2013-20 allocation (m)

(m) 2013 2014 2015 2016 2017 2018 2019 2020 Total

Energa 1.5 1.4 1.2 1.7 1.9 1.5 1.1 0.0 10.4

Enea 5.7 5.3 4.6 3.9 3.9 3.1 2.3 0.0 28.7

PGE 31.0 28.7 25.1 22.1 18.8 15.4 11.4 0.0 152.6

Tauron 12.7 11.9 12.0 11.1 8.7 6.9 5.1 0.0 68.5

Source: BESI Research based Ministry of Economy data

80

100

120

140

160

180

200

220

240

260

280

300

320

Jan-10 Jan-11 Jan-12 Jan-13 Jan-14

Green certificate price Substitution fee

2

4

6

8

10

12

14

16

18

20

22

24

Jan-11 Jan-12 Jan-13 Jan-14

2014 2015 2016 2017

Page 18 of 57

3Q14E Results Preview

On the PL Utilities sector level, 3Q14E should bring a EBITDA and net profit

YoY deterioration, mainly on the back of lower realized energy prices

impacting the Generation segment and margin erosion in the Sales segment

(rising cost burden from yellow and red certificates and rising competitive

pressure). We forecast total PL Utilities sector EBITDA to fall by 16% YoY and

total net profit to decline by 28%. Energa is the only one in the sector we

expect to post a YoY improvement in earnings (a strong 39% YoY increase in

EBITDA and more than doubling of the bottom line), driven by Distribution

(base lowered by VLP provisioning) and Generation (support from operational

reserve) segments. Tauron should report a slight 6% YoY deterioration in

EBITDA, mainly on the back of weaker results in Trading & Sales and

Generation (lower realized energy prices in Generation, though partially offset

by a positive impact from the operational reserve). Both Enea and PGE should

post double-digit YoY declines in EBITDA, by 23% and 27% respectively – in

both cases we expect major declines in the Generation and Sales & Trading

segments.

Compared to PAP consensus estimates for 3Q14, we note that we are slightly

above market expectations for Tauron (+4% vs. consensus on EBITDA and 7%

on NI), but somewhat below for Energa (-3% on EBITDA and -8% on NI). In

terms of PGE and Enea, our forecasts are broadly in line with PAP consensus

estimates.

Table 13 PL Utilities: 3Q14E Results Preview Summary

PLN m 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E YoY, % 3Q14C vs Cns, %

ENERGA

Sales 2,934 2,856 2,748 2,892 2,748 2,539 2,461 -10% 2,469 0%

EBITDA 472 656 374 464 654 628 518 39% 535 -3%

EBIT 282 468 182 262 446 412 303 66% 322 -6%

Net income 192 353 65 153 320 276 199 205% 217 -8%

ENEA

Sales 2,380 2,215 2,192 2,363 2,374 2,466 2,265 3% 2,280 -1%

EBITDA 564 370 467 258 462 642 358 -23% 356 1%

EBIT 370 179 278 71 267 492 179 -36% 184 -3%

Net income 308 144 215 49 208 415 153 -29% 155 -2%

PGE

Sales 7,818 7,283 7,481 7,563 6,929 7,279 6,885 -8% 6,984 -1%

EBITDA 2,282 2,362 2,266 1,115 1,714 2,894 1,649 -27% 1,692 -3%

EBIT 1,548 1,619 1,508 385 975 2,150 905 -40% 932 -3%

Net income 1,228 1,284 1,253 355 789 1,708 732 -42% 743 -1%

TAURON

Sales 5,163 4,542 4,505 4,922 4,887 4,339 4,299 -5% 4,329 -1%

EBITDA 1,221 831 944 665 1,088 906 891 -6% 853 4%

EBIT 788 400 521 225 632 450 434 -17% 407 7%

Net income 558 290 365 95 396 334 288 -21% 270 7%

Sector EBITDA 4,539 4,218 4,051 2,503 3,918 5,070 3,416 -16% 3,436 -1%

Sector NI 2,286 2,070 1,898 652 1,713 2,733 1,372 -28% 1,385 -1%

Source: BESI Research for estimates, Company Data, PAP for consensus estimates

Page 19 of 57

Valuations Summary

Our valuations of PL Utilities are fully based on SOTP valuations (we attach

zero weighting to a peer-comparison-implied valuation), driven by DCFs of

specific segments. We note that in all cases we adjust end-2013 reported net

debt for debt-like provisions and cash-equivalent financial assets (where

applicable), as well as dividends already paid out this year.

Based on the above-described approach, we reach the following Fair Values:

PLN 28.55 for Energa (warranting a BUY and 14% upside potential – our top

pick in the sector), PLN 18.25 for Enea (BUY, 14% upside potential), PLN 20.80

for PGE (NEUTRAL, 6% downside potential) and PLN 5.00 for Tauron

(NEUTRAL, 5% downside potential).

WACC assumptions

Table 14 PL UTILITIES: WACC calculation

ENERGA ENEA PGE TAURON

Tax Rate 19.0% 19.0% 19.0% 19.0%

Debt Ratio 40% 7% 5% 25%

Equity Ratio 60% 93% 95% 75%

Unlevered Beta (x) 0.90 0.90 0.90 0.90

Levered Beta (x) 1.38 0.95 0.94 1.14

Equity risk premium 5.0% 5.0% 5.0% 5.0%

Risk-free rate 3.21% 3.21% 3.21% 3.21%

Cost of Equity 10.1% 8.0% 7.9% 8.9%

Debt risk premium 1.0% 1.0% 1.0% 1.0%

Cost of Debt 4.2% 4.2% 4.2% 4.2%

After-tax cost of debt 3.4% 3.4% 3.4% 3.4%

WACC (%) 7.5% 7.6% 7.7% 7.5%


SOTP Valuations summary

In the tables below, we present details of our SOTP valuations for all four

companies. We note that in this note we are implementing the following

changes to our SOTP valuation approach: (1) we adjust EV not only for

reported net debt (adjusted for dividend already paid out in a given year, if

applicable), but also net debt equivalent provisions; (2) as our segment’s

valuations are based on DCF derived as of beginning of 2014E, in order to fully

account for the time value of money, we roll over the valuation from the

beginning of the year to the current month (November in this case) at the cost

of equity to reach the FV.

Table 15 ENERGA: SOTP valuation summary

PLN m Explicit

(2014-2025E) Terminal Value Asset

Per Share (PLN)

% of EV

Distribution 2,805 7,321 10,126 24.5 67%

Sales 917 1,109 2,026 4.9 13%

Generation - CHP 34 327 361 0.9 2%

Generation - RES 936 2,151 3,087 7.5 20%

Generation - Ostroleka -185 216 31 0.1 0%

Other & Corporate Center -359 -107 -466 -1.1 -3%

Enterprise Value 4,148 11,016 15,164 36.6 100%

Net Debt 3,338 8.1

Minorities & Associates 14 0.0

Net debt equivalent provisions 994 2.4

Equity Value (1 Jan 2014) 10,819 26.1

Shares (m) 414.1

FV 11,821 28.55


Page 20 of 57

Table 16 ENEA: SOTP valuation summary

PLN m Explicit

(2014-2025E) Terminal Value Asset Per Share (PLN) % of EV

Old valuation (PLN per sh.)

% change vs. old

Generation -2,818 4,568 1,750 4.0 21% -4.9 n/a

Distribution 1,203 4,710 5,913 13.4 71% 11.1 21%

Trading & Sales 660 794 1,454 3.3 17% 5.5 -40%

Other & Corporate Center -395 -377 -771 -1.7 -9% -2.9 n/a

Enterprise Value -1,349 9,696 8,347 18.9 100% 8.7 116%

Net Debt -775 -1.8 -3.3 -46%

Minorities 19 0.0 0.1 -15%

Associates 3 0.0 0.0 -45%

Net debt equivalent provisions 1,598 3.6 n/a n/a

Equity Value 7,508 17.0 12.0 42%

Shares (m) 441

FV 8,057 18.25


Table 17 PGE: SOTP valuation summary

PLN m Explicit

(2014-2025E) Terminal Value Asset Per Share (PLN) % of EV Old valuation (PLN per sh.) % change vs. old

Mining & Generation 137 16,548 16,685 8.9 40% 4.0 125%

Renewables 1,769 3,523 5,292 2.8 13% 1.0 196%

Distribution 4,092 9,902 13,994 7.5 33% 5.8 30%

Trading 1,869 1,483 3,352 1.8 8% 1.4 28%

Retail 430 1,251 1,681 0.9 4% 2.0 -54%

Other & intergroup 474 534 1,008 0.5 2% 0.2 164%

Enterprise Value 8,772 33,239 42,011 22.5 100% 14.3 57%

Net Debt -1,404 -0.8 -1.6 -52%

Minorities 266 0.1 0.2 -8%

Associates 9 0.0 0.0 -78%

Net debt equivalent provisions

6,897 3.7

Equity Value 36,260 19.4 15.7 24%

Shares (m) 1,870

FV 38,892 20.80


Table 18 TAURON: SOTP valuation summary

PLN m Explicit

(2014-2025E) Terminal Value Asset Per Share (PLN) % of EV Old valuation (PLN per sh.) % change vs. old

Mining -53 1,266 1,212 0.7 7% 0.6 17%

Generation -6,115 241 -5,873 -3.4 -35% -3.4 n/a

Renewables 766 643 1,408 0.8 8% 0.3 195%

Distribution 2,478 11,236 13,713 7.8 83% 6.6 19%

Trading & Sales 2,530 2,665 5,196 3.0 31% 2.5 18%

Heat 9 1,444 1,453 0.8 9% 0.4 85%

Other & Client service 379 394 773 0.4 5% 0.3 38%

Corporate Center -638 -635 -1,273 -0.7 -8% -0.8 -11%

Enterprise Value -645 17,254 16,609 9.5 100% 6.5 45%

Net Debt 5,796 3.3 2.6 29%

Minorities 0 0.0 0.3 -100%

Associates 44 0.0 0.0 n/a

Net debt equivalent provisions 2,762 1.6 n/a

Equity Value 8,096 4.6 3.7 25%

Shares (m) 1,753

FV 8,756 5.00


Relative valuation summary

We note that our valuations remain fully based on SOTP valuations (each

segment is valued separately based on a DCF model). For illustrative purposes

we have also conducted peer comparisons to Polish and European peers and

present below the multiple-implied valuations (though a zero weighting is

attached when calculating the FVs).

Page 21 of 57

Table 19 PL Utilities: Peer comparison to European peers

Last Price FV Mcap P/E (x) EV/ EBITDA (x) 1Y fwd

Ticker Rating (LCU) (LCU) (EUR m) 2014E 2015E 2016E 2014E 2015E 2016E DY%

PLN PGE PGE PW NEUTRAL 22.10 20.80 9,781 11.2x 13.5x 13.6x 5.3x 6.5x 6.9x 4.5%

PLN Tauron TPE PW NEUTRAL 5.26 5.00 2,182 7.7x 8.2x 9.0x 4.5x 5.0x 5.5x 3.2%

PLN Enea ENA PW BUY 16.00 18.25 1,672 9.2x 12.7x 11.1x 4.7x 6.5x 6.5x 3.8%

PLN Energa ENG PW BUY 25.03 28.55 2,453 10.5x 10.7x 11.8x 6.1x 6.1x 6.4x 4.8%

Median - PL Utilities 10.5x 12.7x 11.8x 5.3x 6.5x 6.5x 4.5%

EUR EDF EDF FP Not Covered 22.9 - 43,803 10.9x 10.4x 10.0x 5.0x 5.0x 4.8x 5.3%

EUR GdF SUEZ GSZ FP Not Covered 18.9 - 46,700 14.7x 13.5x 12.9x 6.8x 6.4x 6.4x 5.2%

EUR E.ON AG EOAN GR Not Covered 13.7 - 27,334 15.6x 15.4x 15.4x 5.6x 5.6x 5.4x 3.8%

EUR ENEL SPA ENEL IM Not Covered 3.9 - 38,272 12.7x 12.0x 11.3x 6.1x 6.0x 5.9x 3.2%

EUR RWE AG RWE GR Not Covered 28.2 - 17,036 12.2x 12.5x 13.1x 4.9x 4.6x 4.4x 3.5%

EUR IBERDROLA SA IBE SM BUY 5.5 6.2 35,579 15.8x 15.3x 14.5x 9.0x 8.7x 8.4x 4.8%

EUR ENDESA SA ELE SM NEUTRAL 15.2 30.0 16,448 9.8x 15.7x 13.9x 4.6x 8.9x 8.3x 45.7%

GBp CENTRICA PLC CNA LN Not Covered 300 - 19,249 14.2x 12.8x 12.2x 6.1x 5.6x 5.4x 5.8%

EUR FORTUM OYJ FUM1V FH Not Covered 18.0 - 16,426 16.1x 17.0x 17.1x 11.1x 11.9x 11.9x 5.8%

GBp SCOTT. & SOUTH. ENERGY SSE LN Not Covered 1,581 - 20,200 13.1x 13.4x 13.1x 10.3x 10.7x 10.2x 5.6%

EUR EDP SA EDP PL BUY 3.3 3.35 12,546 13.5x 13.4x 12.4x 9.3x 8.9x 8.2x 5.5%

EUR VERBUND VAR AV Not Covered 15.9 - 5,602 16.6x 14.1x 11.8x 13.0x 12.1x 11.4x 1.6%

Median - European Utilities 13.8x 13.5x 13.0x 6.4x 7.6x 7.3x 5.3%

PL Utilities vs. European peers -24% -6% -9% -17% -15% -10%


Table 20 PL Utilities: Multiple-implied valuation (for illustrative purposes only)

(PLN) P/E (x) EV/ EBITDA (x)

Weight Average 2014E 2015E 2016E 2014E 2015E 2016E

ENERGA vs. PL peers 50% 25.6 25.0 29.7 25.0 21.1 26.9 25.5



ENEA vs. PL peers 50% 16.9 18.3 16.0 17.1 18.3 15.9 16.0



PGE vs. PL peers 50% 20.9 20.8 20.9 19.2 22.1 22.1 20.4



TAURON vs. PL peers 50% 7.5 7.1 8.1 6.9 6.9 8.3 7.5




Page 22 of 57

Assumptions & Forecasts Summary

EBITDA bridge for all 4 companies

We forecast Energa and Enea to post healthy 3-year EBITDA CAGR (2013-16E)

of 5.4% and 3.9%, respectively. In terms of Tauron, we forecast a stable

earnings outlook in the coming year (2013-16E EBITDA CAGR slightly negative

at -0.3%). We forecast PGE to be the only company to deliver an earnings

decline, with a 3-year EBITDA CAGR of -2.6%.

Energa: We expect earnings growth to be driven by a substantial recovery in

Generation in 2014E (related to the low base of 2013 for Ostroleka resulting

from huge provisioning), as well as healthy growth in Distribution in 2015-16E.

Figure 21 ENERGA: 2013-16E EBITDA bridge (PLN m)


Enea: We expect growth in Enea to come from the Generation (support from

huge LTC compensations in 2014E, as well as cost optimization in the coming

years) and Distribution segments, more than compensating for a material

declines in the Sales segment.

Figure 22 ENEA: 2013-16E EBITDA bridge (PLN m)


PGE: We expect PGE to report a negative 3-year CAGR in EBITDA, with results

declining YoY both in 2014E and 2015E, and only slightly recovering in 2016E.

Huge recurrent earnings decline in Generation in 2014E (resulting mainly from

lower realized energy prices; though we note that reported EBITDA should be

heavily distorted by huge one-offs, adding in total PLN 1.6bn, which distorts

2013-15E YoY dynamics on a reported level) and significant margin erosion in

the Trading & Sales segment should be the key drivers of the expected

earnings decline through 2015E.

1,9652,268 2,321 2,304

-26 -32

360 0 80 -39 12 0 75 6 -98 0

1,667 1,6791,624

1,870

97

80 -140

-25 -5315 -17 0

18358 5 0

Page 23 of 57

Figure 23 PGE: 2013-16E EBITDA bridge (PLN m)


Tauron: We expect a stable outlook for EBITDA through 2016E, with visible

support from the Generation segment (largest positive impact from the

operational reserve mechanism among the PL Utilities) and moderate growth

in Distribution compensating for expected major declines in the Sales

segment.

Figure 24 TAURON: 2013-16E EBITDA bridge (PLN m)


EBITDA breakdown by segment – exposure to regulated business

In terms of EBITDA structure, we believe that greater exposure to regulated

businesses (above all Distribution, but also RES and Heat) should be

supportive for earnings visibility and thus also the dividend outlook. In this

context, we believe Energa should offer the greatest visibility amongst PL

Utilities (in total 89% of our 2015E EBITDA forecast should come from

regulated businesses), while PGE has the lowest visibility / potentially highest

risk of earnings volatility (a mere 38% of 2015E EBITDA is expected to come

from the regulated Distribution and RES segments).

8,0257,574

7,086 7,166 7,265 7,413

611 8 45 -945

-170 -487

90 9 -19 0 99 48 76 24 0

3,661 3,548 3,592 3,631

-87 159 49 16 -302

35 17 32125 18 53 -209

25 0 53 -47 -12 24 15 5 0

Page 24 of 57

Figure 25 PL UTILITIES: 2015E EBITDA composition - Distribution (regulated business) vs.

other


We note that figures for all four PL Utilities are not fully comparable, as PGE

does not break down Generation into conventional generation (not regulated)

and heat production (regulated), while Enea does not break down its

Generation business into conventional generation (not regulated) vs. RES

generation and heat production (both regulated). However, looking only at

the Distribution segment (regulated), which is presented separately by all four

players, we note that in our 2015E EBITDA forecasts breakdown it accounts

for 70% for Energa (supported further by 18% in RES and 2% in CHP), 63% in

Tauron (supported further by 6% in RES and 8% in Heat), 60% in Enea (with

some additional support from RES and Heat, though not presented separately

in our forecasts), but only 32% in PGE (supported by 7% in RES, while Heat is

not presented separately).

Figure 26 ENERGA: 2012-16E EBITDA composition (PLN m) Figure 27 ENEA: 2012-16E EBITDA composition (PLN m)

Source: BESI Research for estimates, Company Data Source: BESI Research for estimates, Company Data

1,615 2,277 976

2,263

706 1,315 648

4,903

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Energa Tauron Enea PGE

Distribution Other

-107 -205

180 141 112261 404

366 413 335

1,225

1,5611,535 1,615 1,691

264

207175 136 142

1,629

1,9652,268

2,3212,304

-250

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2,500

2012 2013 2014E 2015E 2016E

Generation - Conventional Generation - RESGeneration - CHP DistributionSales Other

649 559 657 603786

774 881961 976

1,033

221 251111 94

99

-61 -24 -50 -50 -50

1,5831,667 1,679

1,624

1,870

-250

0

250

500

750

1,000

1,250

1,500

1,750

2,000

2,250

2012 2013 2014E 2015E 2016E

Generation Distribution Trading & Sales Other

Page 25 of 57

Figure 28 PGE: 2012-16E EBITDA composition (PLN m) Figure 29 TAURON: 2012-16E EBITDA composition (PLN m)


Capex overview – huge capex and rising debt seem to be the biggest

challenge for Tauron

The PL Utilities sector has ahead huge capex outlays, mainly in Generation and

Distribution segments, with three out of four plays planning or already

executing large projects in conventional generation capacity extension

(Kozienice by Enea, Opole and Turów by PGE and Jaworzno by Tauron). We

expect total spending by the four PL Utilities in 2014-20E to reach PLN 108bn.

Energa: We expect total 2014-20E capex of PLN 13bn. We forecast only

moderate annual capex of PLN 1.77-1.94bn annually in 2014-16E, mainly in

Distribution and Generation (mainly retrofits in Ostroleka and RES), but with

no major project in new capacities (we are assuming in our model neither a

Grudziadz nor Ostroleka extension project). Given that, we expect that net

debt/EBITDA ratio should reach its maximum of ca. 2.1x end-2017E, not posing

any risks for the dividend policy, in our view.

Enea: We expect total 2014-20E capex of over PLN 17bn, mainly in Generation

(Kozienice project) and Distribution. As spending on Kozienice should peak in

2015E and start falling afterwards, but full earnings contribution of the project

is expected only starting from 2018E, we forecast the net debt/EBITDA ratio

to peak in 2017E at ca. 2.9x, but then fall moderately. In our model we have

assumed acquisitions in RES (totaling almost PLN 2.7bn through 2020E), but

no acquisitions in Heat. Not breaking covenants, at this stage we do not see

major risks towards Enea’s dividend policy in the coming years.

Figure 30 ENERGA: 2012-16E Capex (PLN m) Figure 31 ENEA: 2012-16E Capex (PLN m)


3,725 3,8204,431

3,944 4,043

250 386

394484 531

1,9702,209

2,2542,263 2,339

802

1,271 325306 330

6,791

8,0257,574

7,1667,413

-1,000

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2012 2013 2014E 2015E 2016E

Mining & generation RES Distribution Trading & Sales Other

1,9442,208 2,224 2,277 2,301

83332 192

317 270

478

899 597 388 403

218 232 266 292 297

3,8403,661

3,548 3,592 3,631

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

2012 2013 2014E 2015E 2016E

Distribution Generation Trading & Sales Heat

Renewables Mining Other

1,849

2,805

1,7691,868

1,935

0.9

1.5

1.51.7

1.9

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

0

500

1,000

1,500

2,000

2,500

3,000

2012 2013 2014E 2015E 2016E

Distribution Generation

Sales & Other ND / EBITDA (RHS)

1,803

2,170

3,123

3,631

2,929

-0.9

-0.6

0.5

2.1

2.7

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2012 2013 2014E 2015E 2016E

Generation Distribution

Trading & Sales & Other ND / EBITDA (RHS)

Page 26 of 57

PGE: We expect total 2014-20E capex of over PLN 49bn (of which over

PLN 32bn should be in Generation and PLN 12.3bn in Distribution), with the

peak expected already in 2015E (total spending on Opole and Turów projects

expected to be almost PLN 4.1bn). We forecast the net debt/EBITDA ratio to

remain at reasonable levels, peaking in 2017-18E, but remaining below 2x and

thus leaving room for maintaining the dividend policy in the LT (though we

note that the company needs to stay prepared for huge capex in 2020E+

related to the planned nuclear power project development, which is not yet

included in our forecasts).

Tauron: Huge capex pipeline and already highest debt amongst PL Utilities

expected for the end of this year (net debt/EBITDA of 1.8x) should be the

biggest challenge for Tauron. We expect total 2014-20E capex of almost

PLN 29bn, peaking in 2017E (expected peak of spending on Jaworzno) and

based on our forecasts driving net debt/EBITDA ratio above 3.0x and thus

potentially creating downside risks towards the dividend policy in coming

years. The 2015E dividend payout assumed by us at 25% looks pretty secure in

our opinion, but greater risks may arise for the following years unless the

company manages to reduce debt by disposing of majority stakes in wind

farms (allowing for de-consolidation of related debt of ca. PLN 0.7-0.8bn,

according to the management) or financing some of the projects via

investment vehicles (none of that is included in our forecasts yet, thus

potentially creating room for a debt position improvement).

Figure 32 PGE: 2012-16E Capex (PLN m) Figure 33 TAURON: 2012-16E Capex (PLN m)


Free cash flow & capacity for dividend payment

We expect a deterioration in FCF generation across the sector in the coming

years because of the huge capex pipelines described above. The largest cash

outflow at the sector level is expected by us in 2015E (all four large projects –

Opole, Kozienice, Jaworzno and Turów – in the construction phase, with

spending on Opole and Kozienice projects peaking in 2015E), breaking even in

2018E and turning positive starting from 2019E only (although we remind that

our forecasts do not yet include spending on the planned nuclear power plant

project after 2020E+).

Based on our forecasts, we expect only Energa to maintain positive FCF

generation in the coming years (we are not assuming any major capex in

conventional generation – neither Grudziadz nor Ostroleka extension project).

We expect PGE to return to positive FCF generation in 2018E, while Enea and

Tauron only in 2019E. However, we note that for Enea we have assumed

material acquisitions of wind farms (in line with the management strategy)

through 2020E for a total of PLN 2.7bn. If it were not for forecast spending on

M&A, Enea would turn visibly FCF positive already in 2018E, based on our

forecasts.

4,399 4,619

6,127

10,26610,017

-0.4 -0.4

-0.2

0.7

1.3

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

0

2,000

4,000

6,000

8,000

10,000

12,000

2012 2013 2014E 2015E 2016E

Generation RESDistribution Trading, Sales & OtherND / EBITDA (RHS)

3,4723,780

3,585

4,545 4,636

1.21.4

1.8

2.3

2.8

0.0

1.0

2.0

3.0

4.0

5.0

0

1,000

2,000

3,000

4,000

5,000

2012 2013 2014E 2015E 2016E

Generation Distribution Renewables

Mining Other ND / EBITDA (RHS)

Page 27 of 57

Figure 34 ENERGA: 2014-25E FCF generation (PLN m) Figure 35 ENEA: 2014-25E FCF generation (PLN m)


Figure 36 PGE: 2014-25E FCF generation (PLN m) Figure 37 TAURON: 2014-25E FCF generation (PLN m)


In all, we expect the highest dividend yields in the coming years from Energa

and PGE (4.8-5.0% range for Energa, 3.7-4.5% range for PGE, though rising

YoY for Energa, while falling at PGE), while somewhat lower from Enea and

Tauron (2.8-3.8% range for Enea, 2.2-3.2% range for Tauron, with potential

greatest downside risks in Tauron, as described above). We believe that in the

scenario of low interest rates, healthy dividend yields offered by all the

Utilities plays should be a material support for the sector performance in the

short and medium term.

We note that PGE, Enea and Tauron have defined their dividend policies in

terms of targeted payout ratios: 40-50% for PGE, 30-60% for Enea and 30-

40% for Tauron. Energa sticks to its pre-IPO guidance, set at a PLN 500m

dividend in 2015E, while after 2015E the dividend is to be indexed annually at a

rate equal to or higher than inflation in Poland.

In our model we expect a 2015-16E dividend payout of 50% for PGE (implying

a respective DPS of PLN 0.99 and PLN 0.82 and DY of 4.5% and 3.7%), 35% for

Enea (implying a respective DPS of PLN 0.61 and PLN 0.44 and DY of 3.8%

and 2.8%) and 25% for Tauron in 2015E (in line with the payout ratio from this

year; but below the low-end of the targeted range), falling to 20% in 2016E+.

For Energa, a 2015E dividend of PLN 500m implies a DPS of PLN 1.21 and DY

of 4.8%, while for 2016E we expect a DPS of PLN 1.25, yielding 5.0%.

-300

0

300

600

900

1,200

Generation - Conventional Generation - RESGeneration - CHP DistributionSales Other

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500


-5,000

-4,000

-3,000

-2,000

-1,000

0

1,000

2,000

3,000

4,000

5,000

Generation - Conventional Generation - RESDistribution Sales & TradingOther

-2,500

-2,000

-1,500

-1,000

-500

0

500

1,000

1,500

2,000

Mining Generation - Conventional Generation - RESGeneration - CHP Distribution Trading & SalesOther

Page 28 of 57

Figure 38 ENERGA: Dividend outlook Figure 39 ENEA: Dividend outlook


Figure 40 PGE: Dividend outlook Figure 41 TAURON: Dividend outlook


Generation segment assumptions (conventional, RES and CHP)

Energy prices (baseload)

Below we summarize key assumptions implemented in our models for all four

companies regarding energy price development expectations (baseload),

colour certificate prices assumptions, as well as CO2 emission rights prices.

Table 21 PL Utilities: Key market assumptions on energy prices, colour certificates and CO2 emission rights

2014E 2015E 2016E 2017E 2018E 2019E 2020E

Energy price (PLN/MWh)

Baselad energy price 160.8 172.7 180.9 185.0 188.8 191.3 190.7

Color certificates (PLN/MWh)

Green certificate price 185.1 193.3 208.1 208.1 208.1 208.1 208.1

Red certificate price 10.5 10.5 10.5 10.5 10.5 10.5 10.5

Yellow certificate price 104.5 104.5 104.5 104.5 104.5 0.0 0.0

Purple certificate price 63.0 65.0 66.0 66.0 66.0 66.0 66.0

CO2 emission rights (EUR/t)

ETS Carbon 6.4 6.5 6.7 6.8 6.8 6.8 6.8

EUR/PLN 4.18 4.21 4.21 4.21 4.21 4.21 4.21


Assumptions regarding support mechanisms (operational and cold reserves)

In our models we have accounted for the positive impact of the operational

reserve (total budget assumed at PLN 0.4bn annually in 2014-16E, with Tauron

being the key beneficiary) and cold reserve mechanisms (we have assumed an

annual positive impact of PLN 86m for Tauron and PLN 95m for PGE in 2016-

19E, based on the already conducted tenders).

2.38 2.34

2.12 2.07

1.00

1.21 1.25 1.264.0%

4.8% 5.0% 5.0%

0%

1%

2%

3%

4%

5%

6%

7%

8%

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2014E 2015E 2016E 2017E

EPS (PLN, LHS) DPS (PLN, LHS) DY (%, RHS)

1.74

1.26

1.45

1.61

0.57 0.61

0.440.51

3.6%3.8%

2.8%

3.2%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

0.0

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1.6

1.8

2014E 2015E 2016E 2017E


1.98

1.64 1.62 1.68

1.100.99

0.82 0.815.0%

4.5%

3.7% 3.7%

2%

4%

6%

8%

10%

12%

0.0

0.5

1.0

1.5

2.0

2.5

2014E 2015E 2016E 2017E


0.680.64

0.59

0.49

0.190.17

0.13 0.12

3.6%3.2%

2.4% 2.2%

0%

1%

2%

3%

4%

5%

6%

7%

8%

9%

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

2014E 2015E 2016E 2017E


Page 29 of 57

New law on RES assumed to come into force starting from 2016E

In our models we have assumed the new law on RES to come into force

starting from 2016E, with the following implications: (1) wind farms launched

by the end of 2015E could still operate under the ‘green certificates’ support

system, while the new assets brought to the market in 2016E+ would be

operating under the auctioning system (with still rather limited visibility on

how the reference price for auctions would be established); (2) large hydro

capacities (+5 MW) should lose the current support under the green

certificates system; (3) support for biomass co-firing should be reduced to

only 0.5 green certificates per 1 MWh of produced energy, which at current

green certificates prices would make biomass co-firing unprofitable (and thus

we assume no biomass co-firing starting from 2016E); (4) the remaining ‘green

energy’ sources (wind, small hydro – up to 5 MW, dedicated biomass and

biogas installations) should continue to receive full support in the form of 1

green certificate per 1 MWh of produced energy.

Distribution segment assumptions

RAB – fully remunerated in all 4 companies starting from this year

PL Utilities had different paths for reaching 100% RAB remuneration, but

starting from this year it should be fully remunerated in all of them. In the

table below we present our expectations regarding RAB development for all

four players, which is one of the key drivers for growth in regulated EBIT.

Table 22 PL Utilities: WACC and RAB assumptions

2014E 2015E 2016E 2017E 2018E 2019E 2020E

WACC (%)

WACC accepted by URE 7.28% 7.02% 7.00% 7.00% 7.00% 7.00% 7.00%

Premium for Smart Meters 7.00% 7.00% 7.00% 7.00% 7.00% 7.00% 7.00%

RAB (PLN bn)

Energa 10.6 11.1 11.5 11.9 12.3 12.7 13.0

Enea 6.6 7.0 7.5 7.9 8.3 8.6 9.0

PGE 14.6 15.2 15.8 16.4 17.1 17.8 18.5

Tauron 14.1 14.9 15.8 16.7 17.6 18.4 19.2


Distribution WACC assumptions

Following a 7.28% WACC in 2014E, we have calculated the 2015E WACC

should fall to 7.02%. For 2016E+ we are assuming an equal WACC at 7.0% for

all four PL Utilities players.

Premium for smart meters assumed only for Energa

Only for Energa do we include in our forecasts an additional premium (7%

over WACC for 2014E+) for smart meters.

No quality adjustment implemented in our assumptions for 2016E+ yet

Although some quality measures (based on SAIDI, SAIFI) are expected to be

implemented in the modified distribution remuneration model starting from

2016E, at this stage we do not include any improvement-related additional

compensation (due to still rather limited visibility) into our models.

Page 30 of 57

Sales segment assumptions

Re-launching of red & yellow certificates redemption requirement from May

2014

As of the beginning of May, support for co-generation (red and yellow

certificates) was re-launched, putting additional costs burden on the Sales

segment. This had already had a negative impact on 2Q14 results and should

have a further negative impact in 2H14E and 2015E (contribution for the whole

period vs. only 2/3 in 2Q14).

We expect rising certificates costs to be passed onto clients in mid-term

Following some turbulence after relaunching the support for co-generation,

we assume that in the medium term, PL Utilities should be able to pass on the

majority of the rising costs burden to clients.

Competitive pressure should continue at least in the ST

YTD, we have observed PGE and Enea growing their retail sales volumes

materially. In addition small players have become more aggressive in terms of

attracting new clients, which put downward pressure on the margins in the

Sales segment. We expect this to continue at least in the short term and

normalize starting from 2016E.

Assumption of normalized profitability levels in the LT

In the LT (assumed from 2019E+), for all PL Utilities we have assumed some

margin recovery in the segment to normalized levels.


(v1.0.8.0)

COVERAGE INITIATION


Energa

Good visibility on rising dividends

We initiate coverage on Energa with a BUY recommendation and FV

of PLN 28.55, offering 14% upside potential. Energa is our top pick in

the sector, due to: (1) strong dividend offered in 2015E (DY of 4.8%),

with growth potential in the coming years; (2) good earnings

visibility (substantial exposure to regulated businesses, with

Distribution, RES and Heat accounting for almost 90% of our 2015E

EBITDA forecast), supportive for dividends; (3) healthy cash flows

generation (the only PL Utilities we cover with positive FCF in the

coming years) due to the lack of a heavy capex pipeline in

Generation segment; and (4) preferred generation mix, the most

skewed towards RES amongst the PL Utilities, limiting exposure to

more restrictive EU environmental regulations in the LT.

Business model focused largely on regulated segments

Energa is a large Polish utility with operations focused on distribution and RES.

Combined, these two segments account for 87% of our 2015E EBITDA forecast.

The company’s assets are located primarily in Northern and Central Poland. In

2013, the company distributed 20.4TWh and sold 18.2TWh of electricity (to end-

clients), which makes Energa the 3rd largest player in Poland in both areas. Its

2013 generation volume reached 5.0TWh (7th largest in Poland).

Most RES-oriented PL Utility – LT preferred exposure

We note that in 2013, RES (biomass co-firing included) accounted for almost

40% of Energa’s energy production, by far the highest ratio amongst PL

Utilities (a mere 4% for PGE, 7% for Tauron and 8% for Enea), which makes

Energa the least exposed to risks related to more stringent EU environmental

requirements (on CO2 emission reductions or RES targets) in the LT.

Relatively good visibility on earnings and dividends

Given the above, we believe Energa has relatively good visibility on the mid-term

earnings outlook vs its PL peers. We expect EBITDA to rise at a 2013-16E CAGR of

5.4% given the low base effect (material negative one-offs in 2013) and expected

stable growth in Distribution. Moreover, we also highlight that Energa is investing

in smart meters (we have assumed in total PLN 1.4bn through 2020E), which are

subject to an additional 7.0% return over WACC, offering an additional boost to

Distribution results. Following the management pre-IPO guidance of a 2015E

dividend of PLN 500m, rising afterwards at least at the inflation rate (we expect

PLN 519m in 2016E, thus growth in line with inflation, but believe that room for

positive surprises persist), we believe Energa offers the highest DY (4.8-5.0% in

2015-16E) among PL Utilities.

Deserves a valuation premium to its Polish peers

Energa is trading at a 2015-16E EV-EBITDA of 6.1x and 6.4x, at respective

small 6% and 2% discounts to its Polish peers, while we believe the stock

deserves a premium for the following reasons: (1) contrary to PGE, Energa

offers limited earnings exposure to the most volatile conventional generation,

depending mainly on the fairly predictable regulated business; (2) positive

FCF generation due to lack of any huge project in pipeline in the Generation

segment, which improves visibility on dividends.

BUY 14% upside


Bloomberg ticker ENG PW



Free Float 48%

PLN m Y/E 31-Dec 2013A 2014E 2015E 2016E

Revenues (m) 11429.2 10438.1 10971.1 11329.7

EBITDA (m) 1965.5 2268.0 2321.2 2304.3

Net income (m) 764.0 984.9 968.3 876.8

EPS 1.8 2.4 2.3 2.1

Recurrent EPS 1.8 2.4 2.3 2.1

DPS 1.2 1.0 1.2 1.3

EV (m) 9533.4 13728.1 14241.9 14849.7

Net debt (m) 2923.5 3339.1 3852.9 4460.7

Y/E 31-Dec 2013E 2014E 2015E 2016E

P/E (x) 8.6 10.5 10.7 11.8

EV/EBITDA (x) 4.9 6.1 6.1 6.4

Dividend yield (%) 7.5 4.0 4.8 5.0

FCF yield (%) (8.0) 2.3 1.0 0.6

Capex / EBITDA (x) 0.8 0.8 0.8 0.8

Capex / Depreciation (x) 2.1 2.1 2.0 1.9

Net Debt / EBITDA (x) 1.5 1.5 1.7 1.9

P/E - based on recurrent EPS. 2013 multiples calculated on year-

end prices.



80

100

120

140

160

Jan

2014

Feb

2014

Mar

2014

Apr

2014

May

2014

Jun

2014

Jul

2014

Aug

2014

Sep

2014

Oct

2014

Nov

2014

ENG PW vs WIG Index

Share Price Performance


Page 32 of 57

Summary Financial Information

Valuation Metrics (Year end Dec) 2012 2013 2014E 2015E 2016E

Rating BUY Recurrent P/E (x) n.a. 8.6 10.5 10.7 11.8Fair Value (PLN): 28.55 Reported P/E (x) n.a. 8.6 10.5 10.7 11.8

EV / Sales (x) n.a. 0.8 1.3 1.3 1.3

25.03 EV / EBITDA (x) n.a. 4.9 6.1 6.1 6.4

14% FCF Yield (%) n.a. -8.0% 2.3% 1.0% 0.6%

Dividend yield (%) n.a. 7.5% 4.0% 4.8% 5.0%

#DIV/0!

Key Ratios 2012 2013 2014E 2015E 2016E

ENG PW

ENGP.WA EBITDA margin 14.6% 17.2% 21.7% 21.2% 20.3%

EBIT margin 8.1% 10.5% 13.5% 12.7% 11.5%

Capex / Depreciation (x) 2.5 2.1 2.1 2.0 1.9

Net Debt / EBITDA (x) 0.9 1.5 1.5 1.7 1.9

414 ROE 5.9% 9.7% 11.8% 10.9% 9.5%

10,364

2,923

14 Key Drivers 2012 2013 2014E 2015E 2016E

13,301

Polish baseload power price (PLN/MWh) 200 185 161 173 181

Polish thermal coal price (PLN/GJ) 13.7 11.7 10.2 10.6 10.9

ETS Carbon price (EUR/t) 8.5 4.7 6.4 6.5 6.7

Generation volume (TWh) 4.1 5.0 5.0 5.1 5.3

3Q14 Results 07-Nov-14 Energa RAB (PLN m) 9,419 10,016 10,648 11,062 11,474

Distribution share in EBITDA (%) 75% 79% 68% 70% 73%

P&L Summary (PLN m, unless stated) 2012 2013 2014E 2015E 2016E

Maria Mickiewicz Revenue 11,177 11,429 10,438 10,971 11,330

+48 22 347 40 45 % change 7.8% 2.3% -8.7% 5.1% 3.3%

[email protected] EBITDA 1,629 1,965 2,268 2,321 2,304

% change 7.2% 20.6% 15.4% 2.3% -0.7%

% margin 14.6% 17.2% 21.7% 21.2% 20.3%

Depreciation & Amortisation (723) (771) (861) (927) (997)

* adj. for o ther & internal eliminations EBIT 906 1,195 1,407 1,395 1,307

% change 5.0% 31.9% 17.7% -0.9% -6.3%

% margin 8.1% 10.5% 13.5% 12.7% 11.5%

Associates 0 (1) (1) 0 0

Operating Profit 906 1,194 1,406 1,395 1,307

Net Financials (280) (172) (176) (199) (225)

Other Pre-tax Income 0 0 0 1 1

Pre-Tax Profit 626 1,022 1,230 1,195 1,082

Income Tax Expense (167) (274) (234) (227) (206)

Minority Interests 1 21 (11) 0 0

Net Income 457 764 985 968 877

Recurrent Net Income 457 764 985 968 877

Adj. EBITDA 1,876 2,220 2,268 2,321 2,304

Reported EPS (PLN) n.m. 1.85 2.38 2.34 2.12

Recurrent EPS (PLN) n.m. 1.85 2.38 2.34 2.12

DPS (PLN) n.m. 1.20 1.00 1.21 1.25

Payout Ratio n.m. 109% 54% 51% 54%

Cash Flow Summary (PLN m) 2012 2013 2014E 2015E 2016E

Operating Cash Flow 1,335 2,007 1,853 1,854 1,846

Capital Expenditure & Capital investments (1,817) (1,627) (1,769) (1,868) (1,935)

Free Cash Flow (483) 380 84 (14) (89)

Acquisitions & Disposals, other 17 56 39 0 0

Dividend Paid to Shareholders (654) (497) (414) (500) (519)

Equity Raised / Bought Back 0 0 0 0 0

Other Financing Cash Flow 1,393 382 87 623 682

Net Cash Flow 274 321 (204) 110 74

Balance Sheet Summary (PLN m) 2012 2013 2014E 2015E 2016E

Cash & Equivalents 2,069 2,352 2,148 2,258 2,332

Tangible Fixed Assets 10,001 11,773 12,680 13,621 14,559

Goodwill & Intangibles 407 544 544 544 544

Associates & Financial Investments 17 15 15 15 15

Other Assets 2,419 2,401 2,125 2,208 2,263

Total Assets 14,913 17,085 17,512 18 ,645 19,713

Interest Bearing Debt 3,495 5,276 5,487 6,111 6,792

Other Liabilities 3,699 3,760 3,395 3,436 3,464

Total Liabilit ies 7,194 9,036 8,882 9,547 10,256

Shareholders' Equity 7,671 8,034 8,605 9,074 9,432

Minority Interests 47 14 25 25 25

Total Equity 7,719 8,048 8,630 9,099 9,457

Net Debt 1,440 2,923 3,339 3,853 4,461

Source: Company data, Reuters, Bloomberg, BESI Research for estimates

ENERGA

EBITDA Breakdown (2015E)*

Share Price (31/10/2014, PLN):

Upside / Downside potential

Previous Fair Value (PLN)

% change to fair value

Bloomberg

Reuters

2013 Net Debt (PLN m)

Adjustments for Associates & Minorities (PLN m)

Enterprise Value (PLN m)

Forthcoming Catalysts

EBITDA structure (PLN m, reported)

Margins Trend

ES Equity Research Analyst

Shares in Issue (Less Treasury)(m)

Market Cap (PLN m)

Distribution69%

Sales6%

Generation25%

0%

5%

10%

15%

20%

25%

2012 2013 2014E 2015E 2016E

EBITDA Net profit

1,2251,561 1,535 1,615 1,691

264

207 175 136 142158

223583 594 496

-18 -25 -24 -24 -24

-500

0

500

1,000

1,500

2,000

2,500

2012 2013 2014E 2015E 2016E

Distribution Sales Generation Other & eliminations

Page 33 of 57

We forecast 2013-16E EBITDA CAGR at 5.4%

Figure 1 ENERGA: 2013-16E EBITDA bridge (PLN m)


We expect Energa to post EBITDA of PLN 2,268m in 2014E (+15% YoY, driven

by the Generation segment - Ostroleka), PLN 2,321m in 2015E (+2% YoY, with

growth in Distribution more than compensating for the negative impact of

margin pressure in the Sales segment) and PLN 2,304m in 2016E (slight -1%

YoY decline, with declines in Generation – mainly due to the assumed lack of

green certificates support for the Wloclawek hydro plant – only partially offset

by further growth in Distribution).

Table 1 ENERGA: 2013-16E EBITDA brealdown and key segment assumptions

2013 2014E 2015E 2016E

Generation

EBITDA (PLN m) 223 583 594 496

Total generation volume (TWh) 5.0 5.0 5.1 5.3

CHP 0.1 0.1 0.1 0.1

RES 1.2 1.3 1.3 1.5

Ostroleka 3.6 3.6 3.6 3.6

Total capacities (MW) 1,399 1,444 1,446 1,486

Heat generation volume (PJ) 3.9 4.0 4.1 4.1

Distribution

EBITDA (PLN m) 1,561 1,535 1,615 1,691

Distribution volume (TWh) 20.4 20.4 20.6 20.9

RAB (PLN bn) 10.0 10.6 11.1 11.5

Sales

EBITDA (PLN m) 207 175 136 142

Retail sales volume (TWh) 18.2 16.1 16.1 16.1

Other

EBITDA (PLN m) -25 -24 -24 -24

TOTAL EBITDA (PLN m) 1,965 2,268 2,321 2,304

YoY, % 20.6% 15.4% 2.3% -0.7%


Generation

We forecast Generation EBITDA to recover materially to PLN 583m in 2014E

(vs. a mere PLN 223m last year, with a huge PLN 205m loss reported by

conventional generation segment due to major provisioning for Ostroleka B

and CO2 allowances), stable YoY at PLN 594m in 2015E (+2% YoY), but then

declining to PLN 496m in 2016E (-17% YoY), due to decline in RES. To explain

the key earnings drivers, we would analyze trends in three key sub-segments:

RES (water & wind): We expect EBITDA in RES to decline to

PLN 366m in 2014E, on the back of much weaker performance in

water (weaker YoY volumes due to unfavourable weather conditions),

partially offset by FY consolidation of wind farms (in 1H14, Energa

reported EBITDA of PLN 174m in water – down by a substantial 28%

YoY – and PLN 50m in wind – business acquired only in mid 2013,

thus not contributing in 1H13 yet). In 2015E, we expect EBITDA to rise

1,9652,268 2,321 2,304

-26 -32

360 0 80 -39 12 0 75 6 -98 0

Page 34 of 57

to PLN 413m (slightly rising volumes in wind on addition of 20 MW

this year and further 46 MW next year). 2016E should be negatively

impacted by the expected launch of the new RES law, resulting in the

Wloclawek large hydro plant losing support under the green

certificates system (we estimate a negative impact of almost

PLN 150m). Given that, we expect EBITDA in RES to fall to PLN 335m

in 2016E. Moving forward, we have assumed development of the wind

pipeline to result in the addition of 40 MW annually in years 2016-20E.

CHP: We expect gradual YoY growth in CHP EBITDA to PLN 36m in

2014E (positive impact from launching the new biomass unit in Elblag

mid 2014), PLN 41m in 2015E and PLN 49m in 2016E.

Conventional generation (Ostroleka): We forecast a lack of material

negative one-offs that impacted 2013 figures, some positive one-offs

already reported in 1H14 (reversed CO2 provisioning and gain on sale

of green certificates from biomass co-firing, related to marking to

market the sale price), as well as assuming almost PLN 50m in

support from the operational reserve (assumed to be maintained

through 2016E) will drive EBITDA to PLN 180m in 2014E. Lack of

positive one-offs assumed starting from 2015E and expected limited

support under the new RES law for biomass co-firing (reduced from

1.0 to only 0.5 certificate per MWh) resulting in no co-firing starting

from 2016E, should impact EBITDA of the segment negatively,

dragging it down to PLN 141m in 2015E and slightly further to

PLN 112m in 2016E. Without support from the operational reserve in

2017E, EBITDA should fall sharply then. We note that under current

market conditions, we assume neither execution of the Grudziadz gas

project (500 MW) nor the Ostroleka plant expansion, and therefore

do not include them in our forecasts / valuation.

Distribution

We forecast EBITDA in Distribution to decline slightly this year (by 2% YoY to

PLN 1,535m; 1H14 EBITDA reported at PLN 794m, down 3% YoY), but then

recover to PLN 1,615m in 2015E (+5% YoY) and PLN 1,691m in 2016E (+5%

YoY), together with rising RAB (fully remunerated starting from this year),

rising smart meters premium (assumed 7% premium to WACC for smart

meters in 2014E+), and assumed PLN 20m gains thanks to expected lower

than allowed by the regulator grid losses in 2014-15E, which are expected to

disappear in 2016E+.

Sales

We expect the Sales segment to generate EBITDA of PLN 175m this year

(PLN 126m in 1H14), falling to PLN 136m in 2015E and then recovering starting

from 2016E to PLN 142m. We expect EBITDA to remain under pressure in

2014-15E (competition & rising cost burden from red & yellow certificates;

retail sales volumes declining by 12% YoY this year, but supportive for

profitability, and then assumed to grow annually by 1%), with profitability

stabilizing in 2016E (assuming ability to pass on rising certificate-related costs

to clients). For all companies, we have assumed normalized profitability levels

(margin recovery) starting from 2019E. On the positive side, we note that

rising energy prices should this year already limit losses related to Energa’s

requirement to off-take energy from RES (based on third-party agreements)

at prices above the market (material negative impact on Energa’s results in

2013; no such impact assumed starting from 2015E).

Other

We expect other operations (‘other’ and ‘intergroup eliminations) to

contribute negatively to EBITDA at PLN –24m annually starting from 2014E.

Page 35 of 57

3Q14E Preview: We expect strong EBITDA of PLN 518m, driven by

Distribution and Generation

Table 2 ENERGA: 3Q14E Results Preview

(PLN m) 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E YoY 3Q14C vs cns %

Revenues 2,934 2,856 2,748 2,892 2,748 2,539 2,461 -10% 2,469 0%

Total EBIT 282 468 182 262 446 412 303 66% 322 -6%

EBIT margin 9.6% 16.4% 6.6% 9.1% 16.2% 16.2% 12.3%

Distribution 400 420 316 425 410 384 360 14%

Sales 101 78 9 19 50 77 24 167%

Generation -21 129 91 24 194 179 140 53%

Services 9 8 9 -1 0 0 0 -100%

Other -16 -20 -18 -39 -17 -10 -13 -27%

Internal eliminations -1 40 -33 37 17 -2 7

Total EBITDA 472 656 374 464 654 628 518 39% 535 -3%

EBITDA margin 16.1% 23.0% 13.6% 16.0% 23.8% 24.7% 21.0%

Net financial items -39 -9 -69 -55 -41 -59 -42

Income from associates -1 0 0 0 0 0 0

Net income 192 353 65 153 320 276 199 205% 217 -8%

Net profit margin 6.6% 12.4% 2.4% 5.3% 11.6% 10.9% 8.1%

Key operating figures 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E YoY

Generation volume (TWh, gross) 1.3 1.2 1.3 1.2 1.3 1.3 1.3 0%

incl. RES 0.5 0.5 0.4 0.5 0.5 0.5 0.4 -5%

Distribution volume (TWh) 5.0 5.2 5.0 5.3 5.3 5.1 5.0 1%

Sales volume - retail (TWh) 4.7 4.6 4.3 4.6 4.3 3.8 3.9 -9%

Sales volume - trading (TWh) 3.0 3.1 3.0 3.7 2.7 2.2 2.1 -29%

EBITDA margin on Distribution (%) 42.8% 44.5% 34.3% 42.6% 40.3% 39.7% 37.8%

EBITDA margin on Sales (%) 5.4% 4.5% 0.5% 1.0% 3.3% 5.7% 1.9%


We expect Energa to post strong 3Q14E figures with revenues of PLN 2,461m

(-10% YoY), EBITDA of PLN 518m (+39% YoY) and NI of PLN 199m (+205%

YoY). Key findings:

Distribution: We forecast EBITDA of PLN 360m, up 14% YoY. We have

assumed flat YoY volumes, but a slightly higher margin. The negative impact

of provisioning (due to declining discount rate) should be rather limited

(assumed at ca. PLN 10m).

Generation: We expect EBITDA of PLN 140m (+53% YoY), mainly driven by a

material results improvement at Ostroleka (substantial growth in volumes on

the balancing market & price growth). We expect an immaterial impact from

CHP, a somewhat stronger contribution from wind assets (expected at ca.

PLN 10m at the EBITDA level due to slightly better weather conditions),

partially compensating for weaker results in water (unfavourable hydrological

conditions).

Sales: We forecast EBITDA at PLN 24m (vs. a mere PLN 9m a year before, but

a material QoQ decline due to the full-quarter burden from yellow & red

certificates costs, as well as further competitive pressure). In terms of

volumes, we expect total sales volumes at 6.0 TWh (-17% YoY), while retail

sales volume at 3.9 TWh (-9% YoY).

Other: We expect the net EBITDA impact to be negative at PLN -6m.


(v1.0.8.0)

FUNDAMENTAL INSIGHT


ENEA

First to benefit from new capacities

We are upgrading Enea to BUY (from Sell), having increased our FV to

PLN 18.25 (from PLN 12), which offers 14% upside potential. While

2015E may bring a slight 3% YoY EBITDA contraction following the

huge positive one-off boosting 2014E (PLN 258m LTC compensations),

we expect a healthy earnings recovery starting from 2016E (2013-16E

EBITDA CAGR at nearly 4%). Results should be supported by the first

ever cost optimization programme (management initially targeted PLN

0.5bn in 2014-16E, but we believe there might be higher cost-cutting

potential) and positive impact from assumed wind farm acquisitions

starting from 2016E (in line with Enea’s LT strategy). Moreover, we

note that Enea should be the first of the PL Utilities to benefit from

launching new large capacities (1,075 MW Kozienice project to be

completed mid-2017E). Potential small and mid-size acquisitions in the

regulated Heat segment (part of company’s strategy, but not included

in our model due to low visibility at this stage) could be a potential

additional earnings driver in the coming years.

First ever cost cutting program should have limited delivery risks

We expect the first ever cost optimization program at Enea to be one of the

key earnings drivers in the coming years. Management targets in total

PLN 500m cost savings in 2014-16E (PLN 0.1bn in 2014E and then ca.

PLN 0.2bn each in 2015E and 2016E), but we believe that management’s initial

guidance could be quite conservative given that this is the first such

programme for the group (so should be relatively easy to deliver – i.e. in areas

such centralization of purchases or group reorganization) and unlike other PL

Utilities there have hardly been any cuts in headcount so far. We expect a

total of almost PLN 630m savings in 2014-16E.

Prepared for heavy capex pipeline; dividend should not be in danger

The huge capex plan (PLN 20bn through 2020E, based on Enea’s strategy, but in

our model we are not yet including any acquisitions in Heat) and already peaking

spending on the Kozienice project in 2014E-15E (PLN 1.4bn and PLN 1.7bn,

respectively) should result in Enea moving from net cash to PLN 873m net debt

already this year. However, we believe Enea is quite well prepared for rising capex

(end-2014E net debt/EBITDA of a mere 0.5x), allowing for planned spending on

wind farm acquisitions and maintaining a 35% dividend payout ratio in the coming

years (implying DY of 3.8% and 2.8% in 2015-16E).

First to benefit from adding new large capacities (Kozienice)

Out of four planned/currently executed large projects in conventional

generation in Poland, Enea is the furthest along with its 1,075 MW Kozienice

investment and should also be the first to benefit from adding new capacities,

with a full positive impact on earnings starting from 2018E, with group EBITDA

expected then to rise strongly by over 20% YoY.

Reasonable valuation on EV/EBITDA

Enea is currently trading at an EV/EBITDA of 4.7x for 2014E (at an 11% discount to

its PL peers) and 6.5x for 2015E (in line with peers). We note, however, that the

2014E EV/EBITDA multiple is materially boosted by ca. PLN 3bn capex to be

incurred for the Kozienice project by the year-end, while the EBITDA contribution

(and thus multiple improvement) should start only after 2017E.

BUY 14% upside


Bloomberg ticker ENA PW



Free Float 49%

PLN m Y/E 31-Dec 2013A 2014E 2015E 2016E

Revenues (m) 9150.5 9465.3 9786.0 10244.7

EBITDA (m) 1667.3 1679.3 1624.2 1869.7

Net income (m) 715.4 766.6 555.4 638.8

EPS 1.6 1.7 1.3 1.4


DPS 0.4 0.6 0.6 0.4

EV (m) 6052.1 7951.7 10533.1 12210.9

Net debt (m) (1027.0) 872.6 3454.0 5131.8

Y/E 31-Dec 2013A 2014E 2015E 2016E

P/E (x) 8.4 9.2 12.7 11.1

EV/EBITDA (x) 3.0 4.7 6.5 6.5

Dividend yield (%) 2.6 3.6 3.8 2.8

FCF yield (%) (10.0) (20.7) (20.7) (10.5)

Capex / EBITDA (x) 1.3 1.9 2.2 1.6


Net Debt / EBITDA (x) (0.6) 0.5 2.1 2.7


end prices.



85

90

95

100

105

110

115

120

Jan 2014 Apr 2014 Jul 2014 Oct 2014

ENA PW vs WIG Index



Page 37 of 57



Rating BUY Recurrent P/E (x) 9.9 8.4 9.2 12.7 11.1

Fair Value (PLN): 18 .25 Reported P/E (x) 9.9 8.4 9.2 12.7 11.1

EV / Sales (x) 0.5 0.5 0.8 1.1 1.2

16.00 EV / EBITDA (x) 3.5 3.0 4.7 6.5 6.5

14% FCF Yield (%) -12.2% -10.0% -20.7% -20.7% -10.5%

Dividend yield (%) 3.1% 2.6% 3.6% 3.8% 2.8%

12.00

52%

Key Ratios 2012 2013 2014E 2015E 2016E

ENA PW

ENAE.WA EBITDA margin 15.7% 18.2% 17.7% 16.6% 18.3%

EBIT margin 8.2% 9.8% 10.2% 8.6% 10.1%


Net Debt / EBITDA (x) (0.9) (0.6) 0.5 2.1 2.7

441 ROE (%) 6.5% 6.4% 6.5% 4.6% 5.1%

7,063

(1,027)

16 Key Drivers 2012 2013 2014E 2015E 2016E

6,052




Enea Generation volume (TWh) 11.5 11.9 11.9 12.0 12.2

3Q14 Results presentation 12-Nov-14 Enea Total generation cost (PLN/MWh) 258 246 234 237 233

Distribution share in EBITDA (%) 49% 53% 57% 60% 55%



+48 22 347 40 45 % change 4.2% -9.3% 3.4% 3.4% 4.7%

EBITDA 1,583 1,667 1,679 1,624 1,870

% change 1.7% 5.3% 0.7% -3.3% 15.1%

% margin 15.7% 18.2% 17.7% 16.6% 18.3%

Depreciation & Amortisation (758) (770) (711) (780) (831)

* adj. for o ther & internal eliminations EBIT 825 897 968 844 1,039

% change -2.3% 8.7% 7.9% -12.8% 23.0%

% margin 8.2% 9.8% 10.2% 8.6% 10.1%

Associates 0 0 0 0 0

Operating Profit 825 897 968 844 1,039

Net Financials 61 48 (22) (159) (250)


Pre-Tax Profit 887 945 946 686 789



Net Income 700 715 767 555 639

Recurrent Net Income 700 715 767 555 639

Reported EPS (PLN) 1.58 1.62 1.74 1.26 1.45

Recurrent EPS (PLN) 1.58 1.62 1.74 1.26 1.45

DPS (PLN) 0.48 0.36 0.57 0.61 0.44

Payout Ratio 27% 23% 35% 35% 35%

Shares in Issue (Less Treasury) (m) 441 441 441 441 441



Capital Expenditure (1,803) (2,170) (3,123) (3,631) (2,929)

Free Cash Flow (561) (477) (1,648) (2,312) (1,482)

Acquisitions & Disposals 101 38 0 0 0



Other Financing Cash Flow 550 1,076 1,442 2,619 1,732

Net Cash Flow (123) 478 (458) 38 54






Other Assets 2,399 2,339 2,389 2,455 2,548

Total Assets 14,681 16,322 18 ,241 21,202 23,458

Interest Bearing Debt 75 843 2,198 4,824 6,566





Total Equity 10,914 11,488 12,003 12,289 12,732

Net Debt (1,448) (1,027) 873 3,454 5,132


EBITDA Breakdown (2015E)*


Margins Trend




[email protected]


ENEA





Bloomberg

Reuters


Market Cap (PLN m)


Generation36%

Distribution58%

Trading & Sales

6%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

2012 2013 2014E 2015E 2016E

EBITDA Net profit

649 559 657 603786

774 881961 976

1033

221 251111 94

99

-61 -24 -50 -50 -50-200

0200400600800

10001200140016001800

2000

2012 2013 2014E 2015E 2016E


Page 38 of 57

We forecast an 2013-16E EBITDA CAGR at 3.9%

Figure 1 ENEA: 2013-16E EBITDA bridge (PLN m)


We expect Enea to post EBITDA of PLN 1,679m in 2014E (up by 1% YoY, with

growth in Generation and Distribution – driven mainly by one-offs with the

major one related to the significant PLN 258m LTC compensations – more

than offsetting material declines in Trading & Sales – resulting from rising

certificates costs burden and intensified competition), falling to PLN 1,624m in

2015E (down by 3% YoY, mainly driven by declines in Generation, due to the

lack of positive one-offs) and recovering in 2016E to PLN 1,870m (up 15% YoY,

mainly driven by the expected jump in Generation owing to rising energy

prices, expected full effects of costs optimization as well as the first positive

impact from assumed wind farm acquisitions).

Table 1 ENEA: 2013-16E EBITDA brealdown and key segment assumptions

2013 2014E 2015E 2016E

Generation

EBITDA (PLN m) 559 657 603 786

Total generation volume (TWh) 11.9 11.9 12.0 12.2

Total capacities (MW) 3,192 3,212 3,245 3,350


Distribution

EBITDA (PLN m) 881 961 976 1,033


RAB (PLN bn) 6.2 6.6 7.0 7.5

Trading & Sales

EBITDA (PLN m) 251 111 94 99


Other

EBITDA (PLN m) -24 -50 -50 -50


YoY, % 5.3% 0.7% -3.3% 15.1%


Generation

We forecast EBITDA to grow visibly by 17% YoY to PLN 657m, despite lower

energy prices, being boosted by a major positive one-off from LTC

compensations already reported in 1H14 (PLN 258m). As for the operational

reserve, we do not expect it to be a major earnings driver for Enea (a mere ca.

PLN 18m support expected annually in 2014-16E). For 2015E, we expect

EBITDA to weaken by 8% YoY to PLN 603m, on the back of no full recovery in

energy prices yet (2015E assumed to be the last year negatively affected by

hedging at lower prices) and lack of positive one-offs that should support

2014E (we are not assuming any further LTC compensations after 2014E).

Starting from 2016E, we expect an EBITDA recovery (to PLN 786m in 2016E),

driven by rising energy prices, expected full effects of the cost optimization

programme and positive contribution from an assumed 50 MW wind farm

acquisition. We remind that the initial target of management was to deliver

1,667 1,6791,624

1,870

97

80 -140

-25 -5315 -17 0

18358 5 0

Page 39 of 57

PLN 500m costs savings in 2014-16E, but we believe there might be room for

greater savings given that this is the first cost optimization programme for

Enea and some of the targets should be relatively easy to deliver. We have

assumed a total of almost PLN 630m savings in 2014-16E – of which the vast

majority (PLN 470m) is in the Generation segment.

We note that in our model we have assumed acquisitions of wind farms (total

capex of PLN 2.2bn through 2019E and addition of 335 MW), but no

acquisition in Heat at this stage (though we note that both acquisitions in RES

and Heat are one of the key parts of Enea’s strategy through 2020, with

planned total capex of PLN 4.5bn in RES and PLN 3.2bn in Heat).

Distribution

We forecast EBITDA in Distribution to rise materially by 9% YoY this year to

PLN 961m (1H14 reported EBITDA in Distribution at strong PLN 606m, +18%

YoY), on the back of rising RAB, costs efficiencies and some positive one-offs

already reported in 1H14 to more than compensate for the lower WACC. In

2015E we expect flat YoY EBITDA (mere +2% YoY growth) due to a lack of

positive one-offs, but further growth in RAB and an additional PLN 20m cost

efficiencies assumed more than offsetting a further slight WACC decline.

Starting from 2016E, we expect stable YoY growth in EBITDA (by 6% YoY to

PLN 1,033m in 2016E), driven by rising RAB (annual distribution capex

assumed at PLN 0.9bn).

Trading & Sales

We expect the Trading & Sales segment to generate EBITDA of PLN 111m this

year (PLN 82m in 1H14), falling to PLN 94m in 2015E and then recovering

starting from 2016E to PLN 99m. We expect EBITDA to remain under pressure

in 2014-15E (competition & rising cost burden from red & yellow certificates;

volumes rising by strong 15% YoY this year, but in our view at a cost of

materially declining profitability, and then assumed to grow annually by 1%),

with profitability stabilizing in 2016E (assuming ability to pass on rising

certificate-related costs on clients). For all companies, we have assumed

normalized profitability levels (margin recovery) starting from 2019E.

Other

We are assuming other operations (other non-core activities, intergroup

eliminations and corporate centre costs) to contribute negatively on EBITDA

level at PLN –50m annually starting from this year.

Page 40 of 57

3Q14E Preview: We expect EBITDA of PLN 358m, down 23% YoY, with

major declines in Generation and Sales

Table 2 ENEA: 3Q14E Results Preview

(PLN m) 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E % YoY 3Q14C vs cns

Revenues 2,380 2,215 2,192 2,363 2,374 2,466 2,265 3% 2,280 -1%

Total EBIT 370 179 278 71 267 492 179 -36% 184 -3%

EBIT margin 15.5% 8.1% 12.7% 3.0% 11.2% 20.0% 7.9% 8.1%

Generation 163 81 151 165 124 317 92 -39%

Distribution 280 232 263 105 293 313 267 2%

Trading & Sales 137 76 54 -16 58 24 12 -78%

Other operations 16 24 17 28 7 5 7 -57%

Corporate center -32 -43 -19 -24 -20 -16 -20 n.m.

Total EBITDA 564 370 467 258 462 642 358 -23% 356 1%

EBITDA margin 23.7% 16.7% 21.3% 10.9% 19.5% 26.0% 15.8% 15.6%

Net financial items 15 7 15 12 2 7 10

Income from associates 1 -1 0 0 1 0 0

Net income 308 144 215 49 208 415 153 -29% 155 -2%

Net profit margin 12.9% 6.5% 9.8% 2.1% 8.8% 16.8% 6.7% 6.8%

Key operating figures 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E % YoY

Generation volume (TWh, net) 3.0 2.9 3.1 2.9 3.1 3.0 3.2 3%


Sales volume (TWh) 3.4 3.2 3.2 3.4 4.0 3.8 3.8 20%

EBITDA margin on Trading & Sales (%) 14.3% 8.8% 6.4% -1.7% 5.8% 2.4% 1.2%

Source: BESI Research, Company Data, PAP for consensus estimates

We expect Enea to post weakish 3Q14E figures with revenues of PLN 2,265m

(+3% YoY, mainly on the back of growth in the Trading & Sales segment,

based on volumes growth), EBITDA of PLN 358m (-23% YoY, with declines in

both Generations and Trading & Sales segments) and NI of PLN 153m (-29%

YoY). Key findings:

Generation: We expect EBITDA of PLN 92m (-39% YoY), despite slightly

higher volumes (assumed +3% YoY), due to lower realized energy prices. We

expect a visible QoQ improvement on a one-off adjusted basis (2Q14 ex

PLNM 258m positive impact of LTC compensations), but only minor

improvement at the EBIT level due to higher QoQ D&A (low in 2Q14 due to an

adjustment related to extension of the amortization period for Kozienice).

Distribution: We expect EBITDA of PLN 267m (a mere +2% YoY).

Trading & Sales: We expect further EBITDA deterioration (-78% YoY to a mere

PLN 12m), due to additional red and yellow certificates costs burden.

Other: We expect the net impact of other operations, adjustments for internal

sales and overheads on EBITDA to be negative at PLN –13m.


(v1.0.8.0)

FUNDAMENTAL INSIGHT


PGE

Earnings deterioration on horizon

We reiterate our NEUTRAL rating on PGE. Our new FV of PLN 20.80

(was PLN 15.70) implies 6% downside potential following the strong

YTD rally (+38%, 33pps outperformance vs. WIG). While PGE has a

healthy balance sheet and the highest exposure amongst PL Utilities

to rising energy prices, being the only one long in Generation, we

believe the positives have been already priced in and fully reflected

in its demanding valuation. The stock is trading at 2015-16E

EV/EBITDAs of 6.5x and 6.9x, in line for 2015E, but at a slight 6%

premium to its Polish peers for 2016E, not justified in our view in the

LT due to PGE’s potentially more volatile earnings profile compared

to peers (highest earnings exposure to Generation). While 2014E

EBITDA should be heavily boosted by one-offs in Generation (net

positive impact of PLN 1.6bn expected), 2014-15E earnings should

bring YoY declines and only a slight recovery in 2016E. This should

result in a negative 2013-16E EBITDA CAGR of –2.6%. Together with

declining earnings and having assumed maintenance of a 50%

payout, we expect DPS to contract to PLN 0.99 in 2015E and PLN

0.82 in 2016E (DY of 4.5% and 3.7%, respectively).

Strong balance sheet and highest exposure to energy prices recovery

already priced in

A strong balance sheet vs peers (PGE should be the only PL Utility with a net

cash position as of end 2014E) and highest earnings exposure to the

Generation segment and thus energy prices recovery observed this year

(2014E generation volume expected at 55.2 TWh, with low-cost lignite-fueled

units accounting for 72% of the forecast generation) should be viewed as key

advantages of PGE. However, in our opinion this is already priced in after a

strong 38% YTD rally. On the risks side, we believe this strongest balance

sheet makes PGE most exposed to the potential risk of having to give some

kind of support to loss-making state-owned coal mines.

Expected EBITDA contraction in 2014-15E, implying a slightly negative

2013-16E CAGR

Lower realized energy prices this year and margin erosion in the Sales segment

should put material downward pressure on 2014E EBITDA. While significant

positive one-offs totalling PLN 1.6bn expected in Generation (mainly LTC

compensations and reversed provisioning for CO2) should limit the negative

impact of the above-mentioned factors this year, they would create a high base

for 2015E YoY earnings dynamics. In all, we expect reported EBITDA to fall YoY in

both 2014E (-6%) and 2015E (-5%), recovering only in 2016E (+3%). This however

results in a negative 2013-16E EBITDA CAGR of –2.6%.

Outlook for declining dividends in next two years

Given the expected declines in EBITDA and rising debt burden (PGE expected to

turn from cash positive into net debt territory next year), we expect PGE’s net

income to fall by 10% YoY this year and further by 17% YoY in 2015E. Having

assumed maintenance of a 50% dividend payout, it would imply DPS declines in

the coming two years and a DY reduction from 5.0% paid this year to 3.7% in

2016E. Valuation-wise, PGE is trading in line with PL peers on 2015E EV/EBITDA,

but at a slight single-digit premium for 2016E, not justified in our view.

NEUTRAL 6% downside


Bloomberg ticker PGE PW



Free Float 42%

PLN m Y/E 31-Dec 2013A 2014E 2015E 2016E

Revenues (m) 30144.9 28941.5 29457.1 30185.8

EBITDA (m) 8024.9 7573.7 7166.2 7412.7

Net income (m) 4118.5 3696.7 3069.6 3034.1

EPS 2.2 2.0 1.6 1.6


DPS 0.9 1.1 1.0 0.8

EV (m) 27236.7 40461.1 46310.1 51518.1

Net debt (m) (3460.3) (1140.1) 4690.5 9880.3

Y/E 31-Dec 2013A 2014E 2015E 2016E

P/E (x) 7.0 17.2 14.4 13.5

EV/EBITDA (x) 3.4 5.3 6.5 6.9

Dividend yield (%) 5.3 5.0 4.5 3.7

FCF yield (%) 9.0 0.3 (8.3) (6.6)

Capex / EBITDA (x) 0.6 0.8 1.4 1.4


Net Debt / EBITDA (x) (0.4) (0.2) 0.7 1.3


end prices.



80

90

100

110

120

130

Jan 2014 Apr 2014 Jul 2014 Oct 2014

PGE PW vs WIG Index



Page 42 of 57



Rating NEUTRAL Recurrent P/E (x) 7.3 7.0 17.2 14.4 13.5

Fair Value (PLN): 20.80 Reported P/E (x) 10.6 7.4 11.2 13.5 13.6

EV / Sales (x) 1.0 0.9 1.4 1.6 1.7

22.10 EV / EBITDA (x) 4.6 3.4 5.3 6.5 6.9

-6% FCF Yield (%) 2.0% 9.0% 0.3% -8.3% -6.6%

Dividend yield (%) 10.3% 5.3% 5.0% 4.5% 3.7%

15.70

32%

Key Ratios 2012 2013 2014E 2015E 2016E

PGE PW

PGEP.WA EBITDA margin 22.2% 26.6% 26.2% 24.3% 24.6%

EBIT margin 12.7% 16.8% 15.6% 13.3% 13.4%


Net Debt / EBITDA (x) (0.4) (0.4) (0.2) 0.7 1.3

1,870 ROE (%) 7.8% 9.8% 8.3% 6.7% 6.4%

41,322

(3,460)

257 Key Drivers 2012 2013 2014E 2015E 2016E

38,119

Polish baseload power price (PLN/MWh) 200.1 185 161 173 181



PGE Generation volume (TWh) 57.1 57.0 55.2 55.4 54.5

3Q14 Results 13-Nov-14 PGE Total generation cost (PLN/MWh) 233 180 173 180 184

Mining & generation share in EBITDA (%) 55% 48% 59% 55% 55%



+48 22 347 4045 % change 8.7% -1.3% -4.0% 1.8% 2.5%


% change -0.9% 18.2% -5.6% -5.4% 3.4%

% margin 22.2% 26.6% 26.2% 24.3% 24.6%

Depreciation & Amortisation (2,920) (2,964) (3,057) (3,246) (3,381)

EBIT 3,871 5,060 4,516 3,920 4,032

% change -6.6% 30.7% -10.8% -13.2% 2.9%

% margin 12.7% 16.8% 15.6% 13.3% 13.4%

Associates (13.6) (1.0) 0.0 0.0 0.0

Operating Profit 3,857 5,059 4,516 3,920 4,032

Net Financials 246 (0) 25 (149) (305)

Pre-Tax Profit 4,103 5,059 4,541 3,771 3,727


Discontinued Operations 0 0 0 0 0

Minority Interests (22) (25) (22) (18) (18)

Net Income 3,211 4,118 3,697 3,070 3,034

Recurrent Net Income 4,633 4,352 2,398 2,867 3,061

Reported EPS (PLN) 1.72 2.20 1.98 1.64 1.62


DPS (PLN) 1.88 0.86 1.10 0.99 0.82

Payout Ratio 71% 50% 50% 50% 50%

Shares in Issue (Less Treasury) (m) 1,870 1,870 1,870 1,870 1,870



Capital Expenditure (4,399) (4,619) (6,127) (10,266) (10,017)

Free Cash Flow 2,443 3,322 (263) (3,982) (3,655)

Acquisitions & Disposals 2,448 (1,098) 0 0 0

Dividend Paid to Shareholders (3,506) (1,611) (2,057) (1,848) (1,535)

Equity Raised / Bought Back (0) 0 0 0 0

Other Financing Cash Flow (645) 539 131 5,603 5,277

Net Cash Flow 740 1,152 (2,190) (228) 87






Other Assets 9,375 8,007 8,882 8,949 9,042

Total Assets 58,254 60,751 62,507 69,365 76,183






Total Equity 40,672 43,648 45,310 46,550 48,068

Net Debt (2,899) (3,460) (1,140) 4,690 9,880




EBITDA Breakdown (2015E)


Margins Trend




Bloomberg

Reuters


Market Cap (PLN m)

PGE





Mining & generation

55%

RES7%

Distribution

32%

Trading & Sales4%

Other 2%

0%

5%

10%

15%

20%

25%

30%

2012 2013 2014E 2015E 2016E

EBITDA Net profit

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

2012 2013 2014E 2015E 2016E

Mining & generation Renewable energiesDistribution Trading & SalesOther

Page 43 of 57

We forecast a 2013-16E EBITDA CAGR at -2.6%

Figure 1 PGE: 2013-16E EBITDA bridge (PLN m)


We expect PGE to post EBITDA of PLN 7,574m in 2014E (down by 6% YoY,

mainly driven by a significant decline in the Trading & Sales segment’s margin

erosion and lower realized energy prices in Generation, but in a great part

offset by a major positive one-offs booked in Generation – for the total of

PLN 1.6bn), further declining to PLN 7,166m in 2015E (down by 5% YoY, with

the decline resulting mainly from the high base effect and lack of positive one-

offs in Generation), recovering only in 2016E to PLN 7,413m (up 3% YoY,

mainly driven by a gradual recovery in all the segments, together with rising

realized energy prices, assumed margin stabilization in Sales & Trading and no

major change in remuneration in Distribution, thus earnings rising together

with RAB growth).

Table 1 PGE: 2013-16E EBITDA brealdown and key segment assumptions

2013 2014E 2015E 2016E

Generation

EBITDA (PLN m) 3,820 4,431 3,944 4,043

Generation volume (TWh) 55.6 53.6 53.6 52.4

Capacities (MW) 10,796 10,611 10,611 10,277


RES

EBITDA (PLN m) 386 394 484 531


Capacities (MW) 1,860 1,880 1,987 2,094

Distribution

EBITDA (PLN m) 2,209 2,254 2,263 2,339


RAB (PLN bn) 14.1 14.6 15.2 15.8

Trading & Sales

EBITDA (PLN m) 1,271 325 306 330


Other

EBITDA (PLN m) 339 169 169 169


YoY, % 18.2% -5.6% -5.4% 3.4%


Mining & Generation

We expect reported EBITDA to rise materially YoY this year to PLN 4,431m

(+16% YoY), but we note that both the base and our forecast are heavily

distorted by one-offs. 2013 recurrent EBITDA reached PLN 4,019m and we

expect one-off adjusted 2014E EBITDA to fall to a mere PLN 2,828m (-30%

YoY), mainly on the back of lower realized energy prices and lower volumes.

The total expected positive impact from one-offs on 2014E amounts to

PLN 1.6bn (major positive impact from LTC compensations & adjustment and

reversed provisioning for CO2, partially offset by the negative impact of the

8,0257,574

7,086 7,166 7,265 7,413

611 8 45 -945

-170 -487

90 9 -19 0 99 48 76 24 0

Page 44 of 57

discount rate adjustment related to recultivation of land and provisioning for

the voluntary leave programme). In 2015E, we expect EBITDA to fall by 11%

YoY to PLN 3,944m (or PLN 3,694m if adjusted for the positive impact of LTC

compensations), recovering to PLN 4,043m in 2016E (or PLN 4,076m on a

recurrent basis, adjusted for LTC compensations and assuming some further

VLP provisioning). In 2015-16E, recovering energy prices should be the key

drivers for recurrent EBITDA, supported by the positive effects of the

efficiency improvement programme (PLN 0.5bn already delivered in 2013 at

the group level, of which PLN 0.4bn related to the Generation segment). We

note that the management targets additional efficiencies of ca. PLN 1bn (vs.

the 2013 base) to be fully visible in 2017E. We are more conservative,

assuming that it will take longer to reach the targeted PLN 1bn level (only

around 2019-20E), and in 2017E we expect almost PLN 0.8bn efficiencies (vs.

the 2013 cost base), of which the vast majority should come from the

Generation segment. Starting from 2016E we expect no biomass co-firing

(related to launching the new RES law) and thus no green certificates from

this source, but this should be more than offset by income from the cold

reserve mechanism (PGE won a tender for its two units in the Dolna Odra

power plant), expected to add an additional c PLN 0.1bn annually in 2016-19E.

Renewables

We expect EBITDA in Renewables to be flat YoY this year at PLN 394m (a

mere +2% YoY), as we expect materially higher volumes in wind (due to FY

consolidation of Dond and Iberdrola assets acquired mid 2013), but lower YoY

volumes in water. Starting from next year, we expect EBITDA growth together

with adding new capacities in wind (based on its new strategy, PGE plans to

add 234 MW through 2016E and we assume the addition of 20 MW still this

year, and 107 MW in both 2015E and 2016E) to PLN 484m in 2015E (+23%

YoY) and PLN 531m in 2016E (+10% YoY). We note that only ca. 40% of PGE’s

hydro power plants should continue to receive support in the form of green

certificates under the new RES law, thus we expect a slight negative impact

on the segment’s results of almost PLN 60m annually starting from 2016E, but

more than offset by capacities addition in wind (in all, in 2016E we expect

revenues from green certificates to actually rise slightly YoY by 4%).

Distribution

In the Distribution segment, we forecast PGE to report EBITDA of PLN 2,254m

this year, up 2% YoY despite materially lower WACC, as it is more than

compensated for by rising RAB, cost efficiencies (PLN 26m reported in 1H14,

we assumed the amount to double in FY) and thanks to a lower base (2013

recurrent EBITDA would be ca. PLN 90m higher than the reported one).

Higher RAB, but slightly lower YoY WACC and limited positive impact

assumed from additional cost efficiencies in 2015E should result in flat YoY

EBITDA at PLN 2,263m. Starting from 2016E we expect stable YoY growth in

EBITDA, based on rising WACC and the assumption of no dramatic change in

the remuneration scheme in Distribution in 2016E+. We forecast 2016E

EBITDA of PLN 2,339m (+3% YoY).

Trading & Sales

While PGE reports Trading and Sales segments separately, we believe it

makes sense to analyze and present them together. We expect Trading &

Sales segments to generate total EBITDA of a mere PLN 325m this year (in

1H14 PGE generated EBITDA of PLN 287m in Trading and a loss of PLN 100m

in Sales), falling to PLN 306m in 2015E and then recovering starting from

2016E to PLN 330m. We expect EBITDA to remain under pressure in 2014-15E

(volumes in retail sales assumed to rise by 8% YoY this year, following the

aggressive strategy of attracting new corporate clients, but in our opinion at a

cost to profitability, which together with rising competitive pressure and the

rising cost burden from red & yellow certificates should push EBITDA of the

Sales segment into materially negative territory this year; starting from 2015E,

we have assumed retail volumes to grow annually by 1%), with profitability

Page 45 of 57

stabilizing in 2016E (assuming the ability to pass on rising certificate-related

costs to clients). For all companies, we have assumed normalized profitability

levels (margin recovery) starting from 2019E.

Other

Starting from 2014E, we expect total contribution at the EBITDA level from

other operations (‘other’ and ‘intergroup adjustments’) at PLN 169m annually

(2013 figure adjusted downwards for two material positive one-offs).

Page 46 of 57

3Q14E Preview: We expect EBITDA of PLN 1.6bn, down 27% YoY,

driven by Mining & Generation and Sales & Trading segments

Table 2 PGE: 3Q14E Results Preview

(PLN m) 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E YoY 3Q14C vs cns

Revenues 7,818 7,283 7,481 7,563 6,929 7,279 6,885 (8%) 6,984 (1%)

Total EBIT 1,548 1,619 1,508 385 975 2,150 905 (40%) 932 (3%)

EBIT margin 19.8% 22.2% 20.2% 5.1% 14.1% 29.5% 13.1% 13.3%

Mining & generation 1,094 1,224 1,394 107 812 2,136 905 (35%)

Renewable energies 78 139 78 91 110 98 78 (1%)

Distribution 553 583 603 470 598 585 597 (1%)

Trading 253 233 234 263 166 121 144 (38%)

Sales 264 154 -47 -83 1 -101 -116 n.m.

Other operations 17 42 48 38 29 44 37 (23%)

Adjustment 22 -13 -44 230 -2 11 5 n.m.

Total EBITDA 2,282 2,362 2,266 1,115 1,714 2,894 1,649 (27%) 1,692 (3%)

EBITDA margin 29.2% 32.4% 30.3% 14.7% 24.7% 39.8% 24.0% 24.2%

Net financial income/(expenses) -19 -31 33 17 7 -14 4

Income from associates 0 0 -1 0 0 0 0

Net income 1,228 1,284 1,253 355 789 1,708 732 (42%) 743 (1%)

Net profit margin 15.7% 17.6% 16.7% 4.7% 11.4% 23.5% 10.6% 10.6%

Recurrent net income 1,112 1,028 995 1,202 917 489

Adj. net profit margin 14.2% 14.1% 13.3% 15.9% 13.2% 6.7%


Generation volume (TWh, net) 14.7 13.6 14.5 14.3 13.5 13.1 13.8 (5%)

Sales volume, external (TWh) 8.9 8.9 9.5 9.6 9.9 9.7 9.8 3%


EBITDA margin on Trading (%) 7.4% 8.5% 7.5% 8.2% 6.8% 5.2% 5.5%

EBITDA margin on Sales (%) 7.9% 4.9% -1.5% -2.5% 0.0% -3.4% -3.8%


We expect PGE to post weak 3Q14E results with revenues of PLN 6,885m (-8%

YoY), EBITDA of PLN 1,649m (-27% YoY) and NI at PLN 732m (-42% YoY),

mainly on the back of much weaker results in Generation (lower energy prices

and slightly lower volumes) and Sales & Trading (pressure on margins). Key

findings:

Mining & Generation: We expect EBITDA of a mere PLN 905m, down by 35%

YoY, on the back of lower realized energy prices and slightly lower volumes

(total generation volume expected at 13.8 TWh, down by 5% YoY, following

the switch-off of a 206MW unit in Turów at end-2013 and modernization-

related stoppages in Bełchatów, partially offset by the 858MW Belchatów unit

overhaul moved from August to April). We have assumed PLN 125 LTC

compensations.

RES: We expect EBITDA of PLN 78m, flat YoY (-1%) – with overall slightly

higher volumes YoY (weaker in water, flat YoY on a recurrent basis, but

supported by the new addition of the Wojciechowo wind farm), but weaker

profitability.

Distribution: We expect EBITDA of PLN 597m, flat YoY (-1%). We have

assumed flat YoY volumes (+1%).

Sales & Trading: We expect EBITDA to decline materially by 85% YoY to a

mere PLN 28m on the back of yellow & red certificates costs burden, as well

as intensified competitive pressure in Sales.

Other: We expect a total positive PLN 42m contribution from other operations

and intergroup adjustments (in line with the average quarterly level reported

YTD)


(v1.0.8.0)

FUNDAMENTAL INSIGHT


Tauron

Focus on controlling rising debt burden

We upgrade Tauron to NEUTRAL from Sell, following upward

revision of forecasts (to account for support mechanisms in

Generation, higher energy prices, but lower profitability in Sales),

implementation of a lower RFR and thus an FV increase. Our new FV

of PLN 5.00 (up from PLN 3.7) offers 5% downside potential. While

the company is the most leveraged of the PL Utilities, and still has

huge capex outlays ahead (almost PLN 29bn through 2020E), we

believe Tauron should be able to maintain its reduced dividend

payout ratio of 25% at least in 2015E (DY of 3.2%). LT dividend

payment capacity should depend on the company’s ability to de-

leverage by using investment vehicles and via planned disposals of

majority stakes in wind farms. We forecast stable EBITDA through

2016E (3-yr CAGR at -0.3%), supported materially by the

operational reserve.

Stable earnings outlook in the medium term

(1) Support mechanisms in Generation (Tauron is the key beneficiary of the

operational and cold reserve mechanisms, expected to boost its 2014-19E

EBITDA by almost PLN 1.1bn, translating into PLN 0.41/share if discounted

back & post tax); (2) quite material exposure to regulated businesses

(Distribution, Heat and RES segments account for 77% of our 2015E EBITDA

forecast); (3) given expected materially lower YoY volumes in the Generation

segment starting from this year (-26% YoY in 2014E), 2015E should be again

positively impacted by a lower burden of CO2 costs (positive impact of

reversed provisioning not expected to be fully consumed in 2014E); (4) as well

as expected materially higher cost efficiencies than initially guided by the

management (we expect PLN 385m this year and PLN 425m in 2015E) should

in our opinion lead to a stable earnings outlook in the medium term. We

expect a 2013-16E EBITDA CAGR at -0.3%.

Rising debt should be manageable; room for limited dividend in 2015E

There is apparent investor concern about the sustainability of the dividend

policy because of the rising debt burden. We believe that at least in 2015E, a

limited dividend (at a 25% payout, translating to DPS of PLN 0.17) should be

maintained, yielding 3.2%. Usage of investment vehicles or planned disposal of

majority stakes in wind farm assets to a financial investor (aimed at

deconsolidation of ca. PLN 0.7-0.8bn debt, according to management) should

be supportive for mid-term dividend payment capacity (above-mentioned

actions are not yet included in our model, resulting in our net debt/EBITDA

ratio rising to as much as 3.5x in 2017E).

Valuation: Discount to peers seems justified

Tauron is currently trading at 2015-16E EV/EBITDAs of 5.0x and 5.5x, at

respective 23% and 15% discounts to the PL Utilities sector. However, we

believe the discount is justified by the lowest DY in the sector in 2015E,

already the highest financial leverage (end-2014E net debt/EBITDA at 1.8x)

and negative FCF expected through 2018E. As the key risk, we note that

Tauron still has major capex outlays ahead of it for its largest Jaworzno

project, unlike Enea (offering higher DY, but less attractive valuation

multiples), which has already started material spending on its Kozienice

project, while its BS remains stronger.

NEUTRAL 5% downside

Fair Value PLN 5.00

Bloomberg ticker TPE PW



Free Float 60%

PLN m Y/E 31-Dec 2013A 2014E 2015E 2016E

Revenues (m) 19131.1 17316.9 17979.9 18656.5

EBITDA (m) 3661.5 3547.9 3592.4 3630.8

Net income (m) 1308.3 1190.3 1121.0 1028.8

EPS 0.7 0.7 0.6 0.6


DPS 0.2 0.2 0.2 0.1

EV (m) 13273.2 16078.6 17952.7 19861.5

Net debt (m) 5148.3 6393.9 8268.0 10176.7

Y/E 31-Dec 2013A 2014E 2015E 2016E

P/E (x) 5.9 7.7 8.2 9.0

EV/EBITDA (x) 3.6 4.5 5.0 5.5

Dividend yield (%) 4.6 3.6 3.2 2.4

FCF yield (%) 0.1 (1.9) (7.3) (6.8)

Capex / EBITDA (x) 1.1 1.0 1.3 1.3


Net Debt / EBITDA (x) 1.4 1.8 2.3 2.8


end prices.



80

85

90

95

100

105

110

115

Jan 2014 Apr 2014 Jul 2014 Oct 2014

TPE PW vs WIG Index



Page 48 of 57



Rating NEUTRAL Recurrent P/E (x) 5.7 5.9 7.7 8.2 9.0

Fair Value (PLN): 5.00 Reported P/E (x) 5.7 5.9 7.7 8.2 9.0

EV / Sales (x) 0.5 0.7 0.9 1.0 1.1

5.26 EV / EBITDA (x) 3.5 3.6 4.5 5.0 5.5

-5% FCF Yield (%) -1.4% 0.1% -1.9% -7.3% -6.8%

Dividend yield (%) 6.5% 4.6% 3.6% 3.2% 2.4%

3.70

35%

Key Ratios 2012 2013 2014E 2015E 2016E

TPE PW

TPE.WA EBITDA margin 15.5% 19.1% 20.5% 20.0% 19.5%

EBIT margin 8.7% 10.1% 10.0% 9.6% 9.0%


Net Debt / EBITDA (x) 1.2 1.4 1.8 2.3 2.8

1,753 ROE 8.9% 7.6% 6.5% 5.9% 5.2%

9,218

5,148

-44 Key Drivers 2012 2013 2014E 2015E 2016E

14,322




Tauron Generation volume (TWh) 19.1 19.4 15.3 15.4 15.4

Tauron Total generation cost (PLN/MWh) 313 296 304 312 329

13-Nov-14 Distribution share in EBITDA (%) 51% 60% 63% 63% 63%



+48 22 347 40 45 % change 18.8% -22.7% -9.5% 3.8% 3.8%


% change 27.0% -4.6% -3.1% 1.3% 1.1%

% margin 15.5% 19.1% 20.5% 20.0% 19.5%

Depreciation & Amortisation (1,686) (1,727) (1,814) (1,869) (1,945)

EBIT 2,153 1,934 1,734 1,723 1,686

% change 33.6% -10.2% -10.4% -0.6% -2.2%

% margin 8.7% 10.1% 10.0% 9.6% 9.0%

Associates (1.7) (2.7) 0.0 0.0 0.0

Operating Profit 2,152 1,931 1,734 1,723 1,686

Net Financials (220) (248) (264) (339) (416)


Pre-Tax Profit 1,936 1,684 1,470 1,384 1,270


Minority Interests (74) (38) 0 0 0

Net Income 1,467 1,308 1,190 1,121 1,029

Recurrent Net Income 1,467 1,308 1,190 1,121 1,029

Reported EPS (PLN) 0.84 0.75 0.68 0.64 0.59


DPS (PLN) 0.31 0.20 0.19 0.17 0.13

Payout Ratio 45% 24% 25% 25% 20%

Shares in Issue (Less Treasury) (m) 1,753 1,753 1,753 1,753 1,753



Capital Expenditure & Capital investments (3,472) (3,934) (3,585) (4,545) (4,636)

Free Cash Flow 49 145 (1,565) (1,577) (1,685)

Acquisitions & Disposals, other 245 (14) 652 0 0



Other Financing Cash Flow 635 (131) 1,185 1,896 1,931

Net Cash Flow 386 (351) (60) 22 23


Cash & Equivalents 1,031 637 577 599 621


Goodwill & Intangibles 617 1,407 1,407 1,407 1,407


Other Assets 5,207 4,597 3,694 3,785 3,879

Total Assets 31,274 32,356 33,163 35,952 38,760






Total Equity 16,728 17,793 18,651 19,474 20,279

Net Debt 4,479 5,148 6,394 8,268 10,177


EBITDA Breakdown (2015E)


Margins Trend




3Q14 results presentation


TAURON



Previous Fair Value (PLN):


Bloomberg

Reuters


Market Cap (PLN m)


Mining3%

Power Generation

9%

Renewables6%

Distribution63%

Trading & Sales11%

Heat8%

0%

5%

10%

15%

20%

25%

2012 2013 2014E 2015E 2016E

EBITDA Net profit

-4000

400800

12001600200024002800320036004000

2012 2013 2014E 2015E 2016EMining Power Generation RenewablesDistribution Trading & Sales HeatOther

Page 49 of 57

We forecast a 2013-16E EBITDA CAGR at -0.3%

Figure 1 Tauron: 2013-2016E EBITDA bridge (PLN m)


We expect Tauron to post an EBITDA of PLN 3,548m in 2014E (down 3% YoY,

mainly driven by a significant earnings decline in the Sales segment due to

higher certificate costs burden and rising competition), slightly up to

PLN 3,592m in 2015E (a mere +1% YoY, with positive trends in almost all the

segments more than offsetting further declines in the Sales segment) and up

slightly further to PLN 3,631m in 2016E (a mere +1% YoY, with Mining

contributing the most positively on an expected recovery in coal prices and

slight volume increases, partially dragged down by minor declines in RES and

Generation due to assumed lost support for large hydro and biomass co-firing

under the new RES law).

Table 1 TAURON: 2013-16E EBITDA breakdown and key segment assumptions

2013 2014E 2015E 2016E

Mining

EBITDA (PLN m) 166 79 111 164

Coal production volume (mt) 5.5 5.3 5.5 5.6

Generation

EBITDA (PLN m) 32 192 317 270


Capacities (MW) 4,777 4,671 4,671 4,311


Heat

EBITDA (PLN m) 232 266 292 297



RES

EBITDA (PLN m) 136 185 203 191


Capacities (MW) 318 324 345 345

Distribution

EBITDA (PLN m) 2,208 2,224 2,277 2,301


RAB (PLN bn) 13.2 14.1 14.9 15.8

Trading & Sales

EBITDA (PLN m) 899 597 388 403


Other

EBITDA (PLN m) -12 5 5 5


YoY, % -4.6% -3.1% 1.3% 1.1%


3,661 3,548 3,592 3,631

-87 159 49 16 -302

35 17 32125 18 53 -209

25 0 53 -47 -12 24 15 5 0

Page 50 of 57

Mining

We expect Mining EBITDA of a mere PLN 79m this year (-52% YoY, on the

back of further declining coal prices; 1H14 EBITDA reported a mere PLN 28m,

down 80% YoY), recovering starting from next year to PLN 111m in 2015E

(+40% YoY) and PLN 164m in 2016E (+48% YoY) on an assumed recovery in

coal prices and extraction volumes up a little.

Generation

We forecast Generation EBITDA to bottom out after a very weak 2013 (1H14

reported EBITDA at PLN 127m; in 2013, it was materially negatively affected by

a significant PLN 237m write-down and PLN 270m CO2 provisioning),

reaching PLN 192m this year, then rising to PLN 317m in 2015E (+65% YoY)

and contracting to PLN 270m in 2016E (15% YoY decline). We expect the

operational reserve mechanism, cold reserve mechanism and utilization of

CO2 provisioning created in 2013, limiting CO2-related costs (positive impact

expected in 2014-15E) to be the key EBITDA drivers in 2014-16E. We forecast

the total positive impact from operational and cold reserve mechanisms for

Tauron in 2014-19E at almost PLN 1.1bn (or PLN 0.41/share on a discounted

post-tax basis) – PLN 0.25bn annually from the operational reserve in 2014-

16E and almost PLN 0.1bn annually from the cold reserve in 2016-19E.

However, in 2017E having assumed a lack of support from operational reserve,

we expect Tauron’s EBITDA to fall sharply, recovering only in 2019E after

launching new capacities in Jaworzno.

Heat

We expect a healthy YoY EBITDA improvement in the Heat segment to

PLN 266m in 2014E (1H14 reported EBITDA at PLN 165m), PLN 292m in 2015E

and PLN 297m in 2016E. We expect new capacities in Tychy (50 MWe and 86

MWt) to start fully contributing only starting from 2017E.

Renewables

We forecast EBITDA of PLN 185m in 2014E (up 36% YoY, on the back of rising

volumes in wind, due to launching two new wind farms in 4Q13 – Wicko and

Marszewo – totalling 122 MW; 1H14 reported EBITDA at PLN 97m, up a strong

56% YoY), rising further to PLN 203m in 2015E (+10% YoY), but declining by

6% YoY in 2016E to PLN 191m on the back of lower revenues from green

certificates (lack of support for >5 MW hydro under new RES law that we

expect to be launched in 2016E), only partially offset by further growth of

capacities in wind (extension of Marszewo wind farm by 18 MW to 100 MW).

Moving forward, we are not assuming in our model any further developments

in RES, thus expecting limited YoY growth in EBITDA in the RES segment

starting from 2017E+.

Distribution

We forecast a slight 1% YoY improvement in Distribution this year to

PLN 2,224m, despite the WACC decline, thanks to rising RAB and further

costs optimization (PLN 40m assumed this year and additional PLN 20m

efficiencies assumed next year) and material earnings from the not regulated

business (even up to PLN 0.1bn annually and assumed to decline to a

normalized PLN 50m level in the LT starting from 2016E). Given the above, we

expect EBITDA to slightly improve in 2015E (by 2% YoY to PLN 2,277m) and

2016E (by 1% to PLN 2,301m).

Trading & Sales

We expect the Trading & Sales segment to generate EBITDA of PLN 597m this

year (PLN 392m in 1H14), falling to PLN 388m in 2015E and then recovering

starting from 2016E to PLN 403m. As is the case with all the other PL Utilities,

we expect Tauron’s EBITDA here to remain under pressure in 2014-15E

(competition & rising cost burden from red & yellow certificates; volumes

expected to fall by 7% YoY this year, following trends observed in 1H14, and

Page 51 of 57

then assumed to grow annually by 1%), with profitability stabilizing in 2016E

(assuming an ability to pass on rising certificate-related costs to clients). For

all companies, we have assumed normalized profitability levels (margin

recovery) starting from 2019E.

Other

We are assuming all other operations (‘other’, ‘client service’ and ‘corporate

centre costs’) to contribute slightly positively at the EBITDA level to the tune

of PLN 5m annually starting from this year.

Page 52 of 57

3Q14E Preview: We expect EBITDA of PLN 891m, down 6% YoY,

due to declines in Generation and falling profitability in Sales

Table 2 TAURON: 3Q14E Results Preview

(PLN m) 1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14E YoY 3Q14C vs cns

Revenues 5,163 4,542 4,505 4,922 4,887 4,339 4,299 (5%) 4,329 (1%)

Total EBIT 788 400 521 225 632 450 434 (17%) 407 7%

EBIT margin 15.3% 8.8% 11.6% 4.6% 12.9% 10.4% 10.1%

Mining 73 64 31 -2 20 8 30 (2%)

Generation 167 -129 82 -88 67 60 60 (28%)

Renewable energies 27 35 22 52 56 41 45 105%

Distribution 525 577 594 512 558 612 604 2%

Trading & Sales 348 248 151 152 238 153 103 (32%)

Heat 96 27 39 70 129 36 39 0%

Other operations 2 4 8 3 5 7 8

Client service 12 22 38 -26 40 16 28

Corporate Center -29 -17 -20 -8 -25 -27 -26

Total EBITDA 1,221 831 944 665 1,088 906 891 (6%) 853 4%

EBITDA margin 23.7% 18.3% 21.0% 13.5% 22.3% 20.9% 20.7%

Net financial items -51 -51 -64 -82 -74 -82 -77

Income from associates -1 -1 -1 -1 0 0 0

Net income 558 290 365 95 396 334 288 (21%) 270 7%

Net profit margin 10.8% 6.4% 8.1% 1.9% 8.1% 7.7% 6.7%


Mining volume (mt) 1.5 1.5 1.3 1.2 1.3 1.3 1.3 3%

Generation volume (TWh, net) 5.2 4.6 4.5 5.1 3.7 3.6 3.8 (16%)

incl. RES (TWh) 0.3 0.3 0.3 0.5 0.5 0.4 0.4 25%


Sales volume (TWh) 10.9 9.9 9.9 10.6 10.2 9.1 9.0 (8%)

EBITDA margin on Sales (%) 7.3% 5.9% 3.5% 3.2% 5.8% 4.4% 3.0%

Heat generation volume (PJ) 7.5 1.9 1.2 5.0 5.9 1.9 1.2 0%

LTC compensations (PLN m) 0 0 -19 0 0 0 0


We expect Tauron to post moderate 3Q14E results with sales of PLN 4,299m

(-5% YoY), EBITDA of PLN 891m (-6% YoY) and NI of PLN 288m (-21% YoY).

Key findings:

Mining: We have assumed flat YoY volumes at 1.3mt (+3% YoY) and almost flat

YoY EBITDA of PLN 30m.

Generation: We expect total generation volumes at 3.8 TWh (of which 0.4TWh

related to RES and the remaining 3.4 TWh related to conventional and co-

generation). In the Generation segment, we expect results to continue to be

supported by the operational reserve (positive impact of almost PLN 65m

expected), driving EBITDA to PLN 60m (-28% YoY).

RES: We expect EBITDA to ca. double YoY to PLN 45m due to the

contribution of new Wicko and Marszewo wind farms that were only on a trial

run last year.

Distribution: As in previous quarters, we expect a slight EBITDA YoY

improvement in Distribution (by +2% YoY to PLN 604m), with flat volumes

assumed.

Trading & Sales: We expect this segment to see another quarter of material

YoY and QoQ declines due to rising costs burden from the red & yellow

certificates redemption requirement (re-launched in May 2014, so none last

year and 2Q14 only partially impacted), further competitive pressure and

declining volumes (-32% YoY assumed).

Heat: We have assumed flat YoY volumes at 1.2PJ and we expect a flat YoY

EBITDA of PLN 39m.

Other: We expect ‘other operations’, ‘client service’ and ‘corporate center’ in

total to positively contribute to the EBITDA level at PLN 10m (down from

PLN 25m last year, which was however driven by a positive one-off impact

from the client service segment).

Page 53 of 57

Valuation Methodology

Our valuation methodology for all four companies is solely based on a SOTP

DCF model (100% weight). Below we present company-specific assumptions

utilized in our SOTP valuations.

We also present an implied multiples valuation for comparison – based on

2014E-2016E P/E and EV/EBITDA ratios. We apply a 0% weight to multiples

as our CEE utilities coverage universe is becoming less homogenous in terms

of value chain positioning, asset age and structure.

Energa: We apply a WACC of 7.5%, based on an equity risk premium of 5.0%,

cost of equity of 10.1% and after-tax cost of debt of 3.4%. We assume a long

term growth rate of 2.0% to perpetuity.

Enea: We apply a WACC of 7.6% (down from 8.2%), based on an equity risk

premium of 5.0%, cost of equity of 8.0% and after-tax cost of debt of 3.4%.

We assume a long term growth rate of 2.0% to perpetuity.

PGE: We apply a WACC of 7.7% (down from 8.6% previously), based on an

equity risk premium of 5.0%, cost of equity of 7.9% and after-tax cost of debt

of 3.4%. We assume a long term growth rate of 2.0% to perpetuity.

Tauron: We apply a WACC of 7.5% (down from 8.1%), based on an equity risk

premium of 5.0%, cost of equity of 8.9% and after-tax cost of debt of 3.4%. We

assume a long term growth rate of 2.0% to perpetuity.

Risks to Fair Value

Sector specific risks

Changes in forward electricity prices (vs. our model assumptions),

unexpected changes in commodity, color certificates and carbon

prices.

Lots of local regulatory uncertainty (regarding new RES law,

remuneration scheme in Distribution after 2015E).

Uncertainty over timing/scope of the full-scale capacity market

regulations. At this stage we do not incorporate them in our

estimates. Potential extension / reduction of scale of already

implemented support mechanisms (operational reserve and cold

reserve).

PL energy sector might be pressured to participate in solving the

problem of loss-making coal mines.

Rising burden from costs related to colour certificates and CO2

allowances persists as one of the key risks for the PL Utilities sector in

the LT.

Renewables generation volumes are outside their control and depend

on the weather conditions (hydro, wind).

Risk of generation / heat asset write-downs.

Upside / downside risks related to changes in RFR assumption – both

via calculation of WACC utilized in segments’ DCF valuations, as well

as via the impact on Distribution segment’s results in 2016E+

(regulated business depending on Distribution WACC) and valuation.

Company specific risks

Energa

Potential trade sale to a strategic investor (a likely takeover premium

for a controlling stake), as the company was not included in the

government’s August list of strategic companies for the country.

Page 54 of 57

Highest exposure to any changes in regulations (almost 90% of 90%

EBITDA coming from regulated business lines), therefore more

attractive support mechanisms to Generation at cost of e.g.

Distribution would be most negative for Energa.

Enea

Potential trade sale to a strategic investor (a likely takeover premium

for a controlling stake), as the company was not included in the

government’s August list of strategic companies for the country.

Potential risk related to failing to deliver planned cost efficiency

improvements.

Potential delays in completion of new Kozienice unit or failing to

deliver efficiency improvement targets of the new unit (compared to

current generation fleet).

PGE

Potentially highest exposure to risk of supporting loss-making state-

owned coal mines, due to its still relatively strong BS.

Upside/downside risks (depending on the price and potential

synergies) related to any potential acquisitions in the PL Utilities

sector.

As a leader of the planned nuclear power project, PGE is most

exposed to the risks related to this project, above all depending on

the state’s approach and potential support; potential huge capex

outlays for nuclear project in 2020E+.

Risks related to further deterioration of profitability in retail sales

segment (if company continues to aggressively bid for new clients).

Potential delays in completion of new Opole and Turow project or

failing to deliver efficiency improvement targets of the new unit

(compared to current generation fleet).

Tauron

Risk of ND/EBITDA ratio rising above 3.0x in peak capex years

(unless additional measures including investment vehicles and

disposal of majority stake in wind farm assets are implemented),

which could trigger the renegotiation of debt covenants, a reduction

in capex and/or dividends or – in the worst case scenario – a capital

increase.

Risk of not being able to fully utilize free CO2 emission rights granted

for 2013-20E.

As the key beneficiary of already implemented support mechanisms

for Generation (operational and cold reserve) – most exposed to

potential upside/downside risks to potential extension or limitation of

support.

Potential delays in completion of new Jaworzno project or failing to

deliver efficiency improvement targets of the new unit (compared to

current generation fleet).

Page 55 of 57

Please visit our website at www.EspiritoSantoIB.co.uk for up to date recommendation charts.

Energa ENG PW

Report date Recommendation Fair value Share price (PLN)

Recommendation history is not available

Source: Bloomberg, BESI Research

15.5

16.5

17.5

18.5

19.5

20.5

21.5

22.5

23.5

24.5

25.5

Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 Oct-14 Nov-14

Buy Trading Buy Neutral Trading Sell Sell Restricted Dropped Coverage

ENEA ENA PW

Report date Recommendation Fair value Share price

2013 August 29 Sell PLN 12.00 PLN 13.80

March 6 Neutral PLN 16.80 PLN 15.09

2012 July 24 Buy PLN 18.40 PLN 15.83


S

N

B

12

13

14

15

16

17

18

19

Nov-11 Feb-12 May-12 Aug-12 Nov-12 Feb-13 May-13 Aug-13 Nov-13 Feb-14 May-14 Aug-14 Nov-14


PGE PGE PW


2013 September 12 Neutral PLN 15.70 PLN 16.46


2012 July 24 Sell PLN 18.00 PLN 19.25


NN

S

14

15

16

17

18

19

20

21

22



Tauron TPE PW


2013 August 23 Sell PLN 3.70 PLN 4.59


2012 July 24 Buy PLN 5.80 PLN 4.65


S

N

B

3.5

4

4.5

5

5.5

6



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Page 56 of 57

IMPORTANT DISCLOSURES

101014

This report was prepared by BESI Research, a global brand name for the equity research teams of Banco Espírito Santo de Investimento, S.A., with headquarters in Lisbon, Portugal, of its Branches in Spain and Poland and of its affiliates BES Securities do Brasil, S.A – Corretora de Câmbio e Valores Mobiliários, in Brazil, Execution Noble Limited, in the United Kingdom, and Espirito Santo Securities India Private Limited, in India, all authorized to engage in securities activities according to each domestic legislation. All of these entities are included within the perimeter of the financial group controlled by Novo Banco, S.A., a Portuguese bank authorised and regulated by Banco de Portugal (Portuguese Banking Regulator) and Comissão do Mercado de Valores Mobiliários (the Portuguese Securities Market Authority), which was incorporated on the 3rd of August 2014 in the context of the resolution action taken on the former financial institution Banco Espírito Santo, S.A..

Analyst Certification

Each research analyst primarily responsible for the content of this research report, in whole or in part, certifies that with respect to each security or issuer that the analyst covered in this report: (1) all of the views expressed accurately reflect his or her personal views about those securities or issuers; the issuers were not previously informed about the content of the recommendation included in this research report and the assumptions were not validated by the issuers; (2) no part of his or her compensation is directly or indirectly related to: (a) the specific recommendations or views expressed by that research analyst in the research report; and/or (b) any services provided or to be provided by Banco Espírito Santo de Investimento, S.A. and/or by any of its affiliates to the issuer of the securities under recommendation. Moreover, each of the analysts hereby certifies that he or she has no economic or financial interest whatsoever in the companies subject to his or her opinion and does not own or trade any securities issued by the latter.

Ratings Distribution

BESI Research hereby provides the distribution of the equity research ratings in relation to the total issuers covered and to the investment banking clients as of end of September 2014.

Explanation of Rating System Ratings Distribution

12-MONTH RATING DEFINITION

BUY Analyst expects at least 10% upside potential to fair value, which should be realized in the next 12 months

NEUTRAL Analyst expects upside/downside potential of between +10% and -10% to fair value, which should be realized in the next 12 months

SELL Analyst expects at least 10% downside potential to fair value, which should be realized in the next 12 months

As at end September 2014 Total BESI Research

Total Investment Banking Clients (IBC)

Recommendation Count % of Total Count % of IBC % of Total

12 Month Rating:

Buy 205 46.8% 31 86.1% 7.1%

Neutral 141 32.2% 4 11.1% 0.9%

Sell 90 20.5% 0 0.0% 0.0%

Restricted 1 0.2% 1 2.8% 0.2%

Under Review 1 0.2% 0 0.0% 0.0%

TRADING RATING DEFINITION

TRADING BUY Analyst expects a positive short-term movement in the share price (max duration 3 months from the time Trading Buy is announced) and may move out of line with the fair value estimate during that period

TRADING SELL Analyst expects a negative short-term movement in the share price (max duration 3 months from time Trading Sell is announced) and may move out of line with the fair value estimate during that period

Trading Rating:

Trading Buy 0 0.0% 0 0.0% 0.0%

Trading Sell 0 0.0% 0 0.0% 0.0%

Total recommendations 438 100% 36 100% 8.2%

For further information on Rating System please see “Definitions and distribution of ratings” on: http://www.espiritosantoib-research.com.

Share Prices

Share prices are as at the close of business on the day preceding publication, unless otherwise specified.

Coverage Policy

BESI Research reserves the right to choose the securities it expresses opinions on. The main criteria to choose such securities are: 1) markets in which they trade 2) market capitalisation 3) liquidity, 4) sector suitability. BESI Research has no specific policy regarding the frequency in which opinions and investment recommendations are released.

Representation to Investors

BESI Research has issued this report for information purposes only. This material constitutes "investment research" for the purposes of the Markets in Financial Instruments Directive and as such contains an objective or independent explanation of the matters contained in the material.

Any recommendations contained in this document must not be relied upon as investment advice based on the recipient's personal circumstances. This report is not, and should not be construed as an offer or a solicitation to buy or sell any securities or related financial instruments. The investment discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. The material in this research report is general information intended for recipients who understand the risks associated with investment. It does not take account of whether an investment, course of action, or associated risks are suitable for the recipient. This research report does not purport to be comprehensive or to contain all the information on which a prospective investor may need in order to make an investment decision and the recipient of this report must make its own independent assessment and decisions regarding any securities or financial instruments mentioned herein. In the event that further clarification is required on the words or phrases used in this material, the recipient is strongly recommended to seek independent legal or financial advice. Where an investment is denominated in a currency other than the investor’s currency, changes in rates of exchange may have an adverse effect on the value, price of, or income derived from the investment. Past performance is not necessarily a guide to future performance. Income from investments may fluctuate. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. Any recommendation and opinion contained in this report may become outdated as a consequence of changes in the environment in which the issuer of the securities under analysis operates, in addition to changes in the estimates and forecasts, assumptions and valuation methodology used herein. The securities mentioned in this publication may not be eligible for sale in some states or countries.

All the information contained herein is based upon information available to the public and has been obtained from sources believed to be reliable. However, BESI Research does not guarantee the accuracy or completeness of the information contained in this report. The opinions expressed herein are BESI Research present opinions only, and are subject to change without prior notice. BESI Research is not under any obligation to update or keep current the information and the opinions expressed herein nor to provide the recipient with access to any additional information.

BESI Research has not entered into any agreement with the issuer relating to production of this report. BESI Research does not accept any form of liability for losses or damages which may arise from the use of this report or its contents.

This communication has been issued and approved by Execution Noble Limited in the United Kingdom where it is being directed at persons who have professional experience in matters relating to investments. It is not intended for retail customer use.

Ownership and Material Conflicts of Interest

Banco Espírito Santo de Investimento, S.A. and/or its Affiliates (including all entities within BESI Research) and/or their directors, officers and employees, may have, or have had, interests or qualified holdings on issuers mentioned in this report. Banco Espírito Santo de Investimento, S.A. and/or its Affiliates may have, or have had, business relationships with the companies mentioned in this report. However, the research analysts may not purchase or sell securities or have any interest whatsoever in companies subject to their opinion.

Banco Espírito Santo de Investimento, S.A. and/or its Affiliates have a qualified shareholding (1% or more) in CTT and Oi. Bradesco has a direct qualified shareholding (20%) in BES Investimento do Brasil, S.A., the parent company of BES Securities do Brasil S.A. CCVM.

Pursuant to Polish Ministry of Finance regulations, we inform that neither does Banco Espírito Santo de Investimento, S.A. nor its Affiliates have any qualified shareholding in the Polish Securities Issuers mentioned in this report in excess of 5% of its total share capital.

Mr. Rafael Valverde, a member of the board of Banco Espírito Santo de Investimento, S.A., is a non-executive board member of EDP Renováveis. Mr. Ricardo Abecassis Espírito Santo Silva, the Chief Executive Officer of BES Investimento do Brasil, S.A., is a board member of Brazil Hospitality Group.

Banco Espírito Santo de Investimento, S.A and/or its subsidiaries are liquidity providers or market makers for Altri, Usiminas and Vale.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries participate or have participated in the last 12 months as a syndicate member in share offerings of 4imprint, Alumetal, Capital Park, CTT, EDP, Just Retirement, Klabin, Liberbank, Mota-Engil, NAHL Group, NOS, Oi, PGE, Prime Car Management, REN and SKS Microfinance.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries participate or have participated in the last 12 months as a syndicate member in the bond issues of the following companies: Abengoa, Altri, Bematech, EDP, Globe Trade Centre, Kredyt Inkaso and Sonae.

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Page 57 of 57

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries provided in the last 12 months investment banking services to the following companies: 4imprint, Abengoa, Altri, Alumetal, Bematech, Burford Capital, Capital Park, Casino Guichard, EDP, EDP Renovaveis, Galp Energia, Globe Trade Centre, Inditex, IQE, Just Retirement, Kcom Group, Klabin, Kredyt Inkaso, Kruk, Laird, Liberbank, Mota-Engil, NAHL Group, NOS, Novae Group Plc, Oi, Prime Car Management, REN, Semapa, SKS Microfinance, Sonae, Sonaecom, Sports Direct, SVG Capital, Ted Baker and Xchanging.

Affiliates of Banco Espírito Santo de Investimento, S.A. are partners to Mota-Engil in the infrastructure business in Portugal and other countries. Mota-Engil jointly with ES Concessões, S.G.P.S., S.A. (held by an Affiliate of Banco Espírito Santo de Investimento, S.A.) has created a joint holding company – Ascendi – for all stakes in transportation infrastructure concessions in Portugal and abroad. Banco Espírito Santo de Investimento, S.A. provided, or continues to provide, investment banking services to Ascendi.

Banco Espírito Santo de Investimento, S.A. and/or its subsidiaries do and seek to provide investment banking or other services to the companies referred to in this research report. As a result, investors should be aware that a conflict of interest may exist.

Market Making UK

Execution Noble Limited is a Market Maker in companies covered and may sell to or buy from customers as principal in certain financial instruments listed or admitted to listing on the London Stock Exchange. For information on Companies to which Execution Noble Limited is a Market Maker please see “Execution Noble Limited UK Market Making” on http://www.espiritosantoib-research.com.

Confidentiality

This report cannot be reproduced, in whole or in part, in any form or by any means, without BESI Research’s specific written authorization. This report is confidential and is intended solely for the designated addressee. Therefore any disclosure, replication, distribution or any action taken in reliance on it, is prohibited and unlawful. Receipt and/or review of this research report constitutes your agreement not to redistribute, retransmit, or disclose to others the contents, opinions, conclusion, or information contained in this report (including any investment recommendations, estimates or price targets without first obtaining express permission from an authorized officer of Banco Espírito Santo de Investimento, S.A.

Regulatory Authorities

Portugal: Banco Espírito Santo de Investimento, S.A. is regulated by the Comissão do Mercado de Valores Mobiliários (the Portuguese Securities Market Authority); Spain: the branch in Madrid is regulated by the Comisión Nacional del Mercado de Valores (the Spanish Securities Market Authority); Poland: the branch in Warsaw is regulated by the Komisja Nadzoru Finansowego (the Polish Financial Supervision Authority); Brazil: BES Securities do Brasil, S.A. - Corretora de Câmbio e Valores Mobiliários is regulated by the Comissão de Valores Mobiliários (the Brazilian Securities Market Authority); United Kingdom: Execution Noble Limited is authorised and regulated by the Financial Conduct Authority; India: Espirito Santo Securities India Private Limited is regulated by the Securities and Exchange Board of India.


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