Specialist lenders lead stacked pipeline in ABS
Électricité de France (EDF) shares fell by as much as 25% on Friday morning after the French government announced exceptional measures to limit the impact of high electricity prices on French consumers, at the expense of the energy provider – the shares are down over 30% since start of December.
“A postponement of a portion of the 2022 tariff increase over a 12-month period starting from February 1st, 2023, applying to the residential and “blue professional” regulated tariffs customers, as well as to all professional customers located in the non-interconnected zones, to limit their tariff increase of February 2022 at 4%,” EDF Group said in a statement on Thursday evening.
EDF said the financial consequences of the measures could not be “precisely determined” at this time and would depend on market prices over the implementation period, but that based on prices as of January 12 they would mean an estimated €7.7bn hit to 2022 EBITDA. The company withdrew its net debt and EBITDA guidance for 2022 (as well as its 3x leverage target) and said it would consider appropriate measures to strengthen its balance sheet, adding that it would communicate more at its annual results on February 18 at the latest.
The initial market estimate is that the impact could amount to 45% of consensus EBITDA, although €1.5-1.6bn may be recoverable as a type of tariff deficit and could be added back to EBITDA. The situation has been intensified by the fact that EDF has also cut its full-year French nuclear output guidance by 30TWh to 300-330TWh. This revision is the result of the extension of the outage period for five of EDF's French nuclear reactors. Effectively EDF may have to buy power in the open market at the current spot price in order to sell to competitors at the Arenh price of €42/MWh – likely at a significant loss.
The French government says the measures are to tackle inflation and protect consumers amid Europe’s energy crisis, though they are also likely aimed at boosting support for President Emmanuel Macron ahead of April’s presidential election. EDF is majority-owned by the French state, which clearly makes it easier for the government to take this sort of action. Obviously there are global inflation pressures on energy prices, but this is targeted at a single firm when in other European countries there are perhaps more equitable methods being discussed, such as a VAT cut for energy bills in the UK.
This is not the first time the French Government has used its influence to impact EDF. Just after we launched our Corporate Bond Fund in January 2015, we owned EDF corporate hybrids. During 2015, however, the main nuclear supplier to EDF, Areva, got into difficulties and required a capital injection. Given the French state’s shareholding in EDF, they essentially instructed the company to support (and ultimately acquire) Areva, which prompted us to review our holding. Our fear was that this capital call could put EDF’s dividend at risk, and corporate hybrids (because of their deferrable coupons) are in our view an instrument you should reconsider owning in companies that are cutting or even stopping dividends, as they can choose to miss coupon payments when things are tight. We sold our holding, and the bonds didn’t move for a couple of months. We scratched our heads and wondered what we were missing, but eventually the spread more than doubled to around 700bp as reality set in, making it one of the worst performing sterling corporate bonds of that year. Seven years on we still wouldn’t consider EDF an acceptable risk and the latest news has reemphasised this.
EDF is one of the largest issuers of hybrids with €17bn of debt outstanding. Their current hybrids are rated investment grade by Moody’s (Baa3) and Fitch (BBB) and sub-IG by S&P (BB-), meaning these bonds currently sit in certain investment grade indices. However, this news could prompt the rating agencies to reassess their ratings and EDF could be downgraded to high yield at the hybrid level. The hybrid bonds could thus drop out of the IG index, causing further selling pressure from IG investors on top of the margin pressures that will be felt from the French government's intervention. EDF’s senior bonds were 10-20bp wider across the curve on Friday morning and its hybrid bonds were 0.5-2pts lower. While the full impact is yet to be seen, it is fair to say the French government’s action has not been taken well by the market.
As fixed income investors we need to be aware of downside risk to all positions. This latest chapter in the EDF story is one example of why we are particularly wary of companies with large government stakes. Governments will be tempted to influence company decisions when it suits them, and this can significantly hinder a bond issuer’s ability to pay dividends and potentially defer the coupons of hybrid instruments.