We present our note on Fortum Oyj (OTCPK:FOJCF), a major power utility in the Nordics. We are drawn by Fortum’s strong asset base, attractive valuation, robust FCF generation, and hefty dividend yield. After the agreement with the German government over Uniper, the business is largely de-risked, and we find the equity story compelling. We will provide a brief overview of Fortum, discuss Q2 results, analyze the complex issues faced by Fortum in the last year, and lay out our investment case and valuation.
Introduction to Fortum
Fortum is a Finland-based power utility company, mainly focused on the Nordic region. It generates power mainly from nuclear power plants and hydro, and it is one of the largest energy solutions providers in the region. 84% of the company’s €2 billion EBITDA in FY2022 was derived from Generation activities including 150 power plants in total, 8% from Consumer Solutions, i.e., electricity and gas retail business in the Nordics, Poland, and Spain, and 8% from City Solutions, i.e., waste services, environmental construction services, etc. Fortum is the third-largest power generator and largest electricity retailer in the Nordics, a highly fragmented utility market with clean power and competitive prices. The Finnish state owns 51.26% of the company’s shares, while the rest is free float. Fortum is listed on the Nasdaq Helsinki and has a market capitalization of €11.2 billion.
Fortum had a slight below-expectations Q2 results print. Although operating profit and EPS came in line with expectations, EBIT was a tad below sell-side analyst consensus, while leverage looks comfortable vis-à-vis long-term targets. Operating performance was driven by higher realized power prices post hedges in Generation activities, and the company committed to invest €225 million in two heat projects in Finland, and acquire Telge Energi AB, a Swedish electricity retailer previously owned by the municipality of Södertälje for SEK450 million or €38 million. Moreover, the strategic review of Circular solutions with an EBITDA of €70 million and ca. €700 million of assets will further simplify the portfolio
Russian Operations And Uniper Woes
Fortum’s Russian assets have been placed under “temporary control” by Moscow in response to EU sanctions. Fortum has entirely written off its seven thermal power plants and a portfolio of wind and solar assets, with a total value of €1.7 billion. The company still has legal ownership of the business but does not get any information, dividends, etc. from there. For the purposes of our valuation exercise, we value Fortum’s Russian assets at 0. However, we would like to point out that Fortum has taken legal action against Russia and expects the arbitration process to start next year, claiming a few billion euros. While Russia is unlikely to respect any potential ruling in favor of Fortum and award damages, management has alluded to asset swaps, i.e., getting ownership of Russian assets held abroad. We believe this represents at least some attractive option value, and we will closely monitor the situation.
Fortum deconsolidated Uniper thanks to a deal with the German government in 2022 as the German state underwrote €8 billion of an equity increase and the German state acquired all of Fortum’s share for approximately €500 million. Fortum’s €4 billion loan was repaid and the parent company guarantee was released. This puts an end to Fortum’s major trouble as losses have been crystallized, and the company is clean and ready to move forward.
Investment Case And Valuation
We believe Fortum represents a clean equity story and a play on clean Nordic power, with an underleveraged balance sheet and a sustainable dividend. Fortum has announced its plan to deliver clean energy by investing €1.5 billion over the mid-term, more than half of which will be in renewables. Moreover, we believe Fortum has €4-5 billion of additional headroom to support growth. The company aims to achieve an IRR of 150-400 basis points in excess of its WACC and pay out 60-90% of its net income to shareholders. Depending on capital allocation, we think this will create additional value for the company and drive the stock’s re-rating.
We forecast €6.8 billion of sales in FY2024, and an EBITDA of €1.8 billion, largely in line with sell-side analyst consensus. Our EPS estimate stands at €1.15, implying a 10% decline over our 2023e EPS estimate. We forecast 85% FCF conversion, and a dividend payout ratio of 78% arriving at a dividend of 90 cents per share. This implies a 10.9x forward PE ratio and a 7.2% forward dividend yield at the current share price. Moreover, we forecast 95 cents per share of dividends in FY2023e, in line with consensus, implying a 7.6% dividend yield
We find this attractive vs. the broader utility sector space. We value Fortum at a target 12x EPS24e, implying a share price of €13.8, plus dividends. This implies a 10% share price upside plus ca. 15% dividends in two years, or a cumulative TSR of 25%.
Downside risks include but are not limited to a decline in power prices, soft macro affecting demand for electricity and gas, lower electricity generation from hydro and nuclear power plants, flooding or draughts affecting hydro generation, higher potential taxation, and one-off excess profit/windfall taxes, adverse changes in regulation, capex execution risks, etc.
Given the attractive valuation, strong FCF generation, and high dividend yield, we recommend building a long position in Fortum shares.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.