Rising CapEx And ARERA Rules Will Compress Margins

Key Takeaways

• Increased competition and regulatory changes may lead to margin compression and impact Hera's profitability and growth in the electricity supply market.
  
• Capital expenditure on new projects could pressure free cash flow and elevate debt, affecting net margins and future earnings growth.
  
• Hera's robust growth, diversified business lines, strategic acquisitions, and focus on sustainability enhance financial flexibility and position it for long-term revenue and earnings growth.

Catalysts

A multi-utility company, engages in the waste management, water services, and energy businesses in Italy.

• The anticipated end of the Salvaguardia and last instance markets in 2025 may lead to a decrease in the margins for Hera's electricity supply business, impacting future revenue and earnings.
  
• Competitive pressure in the energy supply market is increasing, potentially leading to margin compression as smaller players exit and larger players offer competitive rates, which could negatively impact Hera's net margins.
  
• The normalization of opportunities in the electricity supply business following the expiry of the Super Ecobonus could weigh on revenue growth, impacting profitability.
  
• Expected increases in CapEx due to new projects and acquisitions (e.g., AIMAG integration), despite contributing to growth, could put pressure on free cash flow and lead to higher debt levels in the short term, affecting net margins.
  
• Dependence on regulatory decisions, such as those from ARERA regarding electricity distribution concessions and associated costs, introduces uncertainty regarding future investment plans and could affect the returns on future regulated asset base (RAB), thereby impacting overall earnings growth.

Hera Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Hera's revenue will decrease by 1.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 3.6% today to 3.7% in 3 years time.
• Analysts expect earnings to reach €499.3 million (and earnings per share of €0.33) by about July 2028, down from €505.1 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 13.9x on those 2028 earnings, up from 10.8x today. This future PE is greater than the current PE for the GB Integrated Utilities industry at 11.5x.
• Analysts expect the number of shares outstanding to decline by 2.58% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.58%, as per the Simply Wall St company report.

Hera Future Earnings Per Share Growth

Risks

• Hera has demonstrated robust growth in key financial metrics, including EBITDA and net profit, showing a 29% year-on-year growth in net profit. This suggests the company is effectively managing its operations and achieving structural growth, which could support earnings.
  
• The company's diversified business lines—energy supply, waste, and networks—all contributed positively to EBITDA. Diversification helps mitigate risks from any single segment and supports overall revenue growth and financial stability.
  
• Hera's strong cash generation, evidenced by its ability to generate substantial operating cash flow and maintain a favorable net debt-to-EBITDA ratio of 2.5x, indicates solid financial flexibility and potential for reinvestment or strategic initiatives to enhance margins or earnings.
  
• M&A activity continues to be strategic for Hera, evident from its ongoing acquisition strategy, such as the recent acquisition of Ambiente Energia. This strategic approach to acquisitions in a highly fragmented market can create synergies and fuel growth, impacting long-term revenue and earnings.
  
• Hera's focus on sustainability and the circular economy, achieving significant growth in shared value and circular initiatives, positions it to capture opportunities from environmental regulations and consumer trends, potentially enhancing long-term revenue streams and profit margins.

Valuation

• The analysts have a consensus price target of €4.175 for Hera based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be €13.4 billion, earnings will come to €499.3 million, and it would be trading on a PE ratio of 13.9x, assuming you use a discount rate of 8.6%.
• Given the current share price of €3.89, the analyst price target of €4.18 is 6.8% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.