ema asset management’s valuation webinar series...china. developing economies (excl. china)...

© 2020 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved.

EMA Asset Management’s Valuation Webinar Series

1 July 2020

Valuation of Infrastructure and renewables investments


SpeakersModerator Panellists

Alexis Wolf PartnerKPMG Luxembourg

t: +352 22 51 51 72 23m: +352 621 877 223e: [email protected]

Russell Smyth PartnerKPMG Ireland

t: +44 28 90 89 38 14m: +44 77 38 60 38 69e: [email protected]

Luc van RooijenPartnerKPMG Netherlands

t: +31 20 656 8524m: +31 65 336 0628e: [email protected]

Wenceslao SerranoDirectorKPMG United Kingdom

t: +44 207 311 3249m: +44 779 664 6494e: [email protected]

© 2020 KPMG, an Irish partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative, a Swiss entity. All rights reserved. 3

Introduction


Material short term effectsIt will be a consequence of both the direct impact of the illness and the measures taken to slow its spreadEurozone estimated gross domestic product contraction of 5.9% for 2020.

Global economy material impact

European countries responses through fiscal and monetary policies Companies postpone or cancel dividend paymentsInflation levels are likely to be suppressed in the short-term as weakness in demand combines with falling global oil prices.

Deposit rates and inflation impact

The European Central Bank (ECB) has assessed a €1.3 trillion emergency purchase plan in an effort to help to mitigate the impact of the coronavirus outbreak, looking to acquire public and private securities to counter the risks of the coronavirus

ECB plan

Economic impact of Covid-19 on valuations


GDP growth estimate change

2.3%

5.9%

1.7%0.9% 1.0% 1.0% 0.4%

(4.2%)

1.0%

(4.0%)

(6.1%)

(8.7%) (8.8%)

(10.8%)Global China US Germany UK France Italy

2020 Real GDP growth before COVID-19 2020 Real GDP growth after COVID-19

Year-on-year % change forecast before and after COVID-19

Sources: Economist Intelligence Unit forecasts, 22 May 2020, KPMG analysis

There is uncertainty concerning the economic recovery: scenarios are developed based on (i) the virus spread, mutation and public health response, and (ii) on the effectiveness of the economic policies applied. The Eurozone is one of the hardest hit regions, with an economic contraction exceeding 8% in 2020.


Euro Stoxx50 Index

Sources: Thomson Reuters Eikon; KPMG analysis

inde

x va

lue

1 January 2019 - 16 June 2020

1,500

1,750

2,000

2,250

2,500

2,750

3,000

3,250

3,500

3,750

4,000

2019 index growth: 25.1%

2 January 2019 to 16 June 2020: 8.3% increase

2 January 2020 to 16 June 2020: -14.5%


Share-price resilience since 1 January 2020

European infrastructure companies

Sources: S&P Capital IQ, ThomsonOne, KPMG analysis

Reb

ased

sha

re p

rice

(100

) Sector accumulated change since 1 January 2020

Airport operators: -26.8%Telecommunications: -12.2%Water*: -7.0%Toll road operators: -12.9%Port operators: -14.0%Energy*: +0.2%

20

30

40

50

60

70

80

90

100

110

120

Airport operators Telecom Water Tollroad operators Port operators Energy

*Regulated and unregulated


10Y European government bond yields

Sources: Thomson Reuters Eikon; KPMG analysis

Rat

e

-1.5%

-0.5%

0.5%

1.5%

2.5%

3.5%

France Germany Italy Spain United Kingdom

Impact of Covid-19 pandemic in the EU (government stimulus and support packages, restrictions on places of business, restrictions on movement) leads to volatility in the bond markets.


Demand-based infrastructure

assets


,40

,60

,80

,100

31-Dec-19 31-Jan-20 29-Feb-20 31-Mar-20 30-Apr-20 31-May-20

Shar

e pr

ice

reba

sed

to 1

00

Airport operators Port operators Tollroad operators

,40

,60

,80

,100

31-Dec-19 31-Jan-20 29-Feb-20 31-Mar-20 30-Apr-20 31-May-20

Shar

e pr

ice

reba

sed

to 1

00

MSCI World Airport operators Port operators Tollroad operators

Covid-19 impact 94

68

86

56

86

74

64

67

Source: S&P Capital IQ, ThomsonOne, KPMG analysis

Covid-19 European Toll Roads, Ports and Airports share price impact

Listed European Airports have been most affected and almost halved in value mid March, to recover to a reduction of c. 25% currently. Toll roads and ports fared slightly better with an initial drop of c. 35% to recover to c. 15%. Partly driven by reliance on domestic travel and transport of goods.

Privately held assets are less severely affected. Airports still show significant double-digit drops, but not as low as listed assets.Some more resilient ports only saw single-digit impact and toll roads tend to lie between ports and airports.

Covid-19 market response was a general fall in share prices, with gradual recovery.Whereas MSCI world average reduction since 2019 year end is currently only c. 6%, volume based asset are still significantly more affected.


Covid-19 impact on valuations of demand based assetsImpact on financing

In order to maintain liquidity and ratios, deferral of (non-essential) CAPEX investments anticipated in the short and medium term

Delay in CAPEX investments

Impact on traffic volume

COVID-19 and lock-down measures have had a dramatic impact, including sudden drops in traffic volumes and disruption in global supply chains resulting in an immediate effect on short-term cash flows, but also long-term forecasts for volume based assets.

Re-forecasting based on scenariosImpact results mainly in liquidity driven issues and potential future impact on debt covenants, requiring business to re-forecast based on various scenario’s, including voluntary and mandatory deferral of equity distributions.

Lenders may become increasingly more selective, with reduction in appetite for volume based assets. Widening of credit spread (albeit slightly contracting again more recently) will push up refinancing costs. History of actuals showing recovery paths during previous crises helps lenders get (more) comfortable.

Public vs PrivatePrivately held assets show on average a less severe value impact than listed assets, but directions are comparable.

Investor sentimentCertain transactions have still gone ahead, showing investors taking a longer term view on value, whereas some others have temporarily been put on hold.

Uncertain recovery due to changing behaviourChanging customer behavior in respect of inclination to travel and acceleration to more digital working solutions requiring less travel creates higher uncertainty around traffic rebound and recovery timelines for toll roads and airports


(,10%)

(,5%)

-

,5%

,10%

1996 2000 2004 2008 2012 2016 2020

GDP growth in comparison to air traffic growth - passenger

Air traffic GDP GDP 2020F

(,10%)

(,5%)

-

,5%

,10%

1996 2000 2004 2008 2012 2016 2020

% c

hang

e (y

-o-y

)

GDP growth in comparison to air traffic growth - passenger

Air traffic GDP GDP 2020F

(,25%)

(,15%)

(,5%)

,5%

,15%

2006 2008 2010 2012 2014 2016 2018 2020

% c

hang

e (y

-o-y

)

Total trade value vis-à-vis volume by mode of transport

Air transport Port transport Road transport

Total trade Total trade 2020Q1

Historical impacts and recoveries

Ports and toll road have a strong correlation with the overall economic cycle and are likely to follow the broader trendHowever, disruption in supply chain and growing demand to procure locally may impact flow of goods in the short to medium term.

Historically, movements in air traffic have shown strong correlation with GDP and a tendency to bounce back strongerHowever, current health crisis is likely to slow down air traffic recovery for a longer period due to the combination of government restrictions and public fear.

Source: EIU, WTO, Eurostat, KPMG analysis

Asian financial crisis

9/11 attacks

Global recession

European debt crisis Covid-19

Global recession

European debt crisis

2015 Crude oilDemand slowdown

and Covid-19


GDP forecasts

,85

,90

,95

,100

,105

,110

,115

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2019 2020F 2021F

Quarterly World GDP

Advanced economies World China Developing economies (excl. China)

2019:Q1 = 100

Major European economies such as the UK, Spain, Italy and France are expected to register double digit GDP decline in 2020. During 2021 the growth is expected to be positive, however, still a decline when compared to pre-Covid levels.

Europe is expected to show a much more lengthy recovery path than the rest of the world, with China expected to lead.

Impact during the Q1’20 has been more severe then anticipated and the recovery is expected to be gradual than previously forecasted. IMF is projecting Euro area’s GDP to decline 10.2% for 2020.

Source: IMF, KPMG analysis


Regulated utilities


The emergence of the Covid-19 pandemic, and global measures to stem its spread, have created uncertainty in the infrastructure markets globally

Demand based assets, particularly those exposed to the transport sector or directly correlated with GDP performance, have felt the largest value impact from the pandemic as countries entered lockdowns of varying levels of severity across the globe

By contrast, regulated utilities such as gas/electricity transmission / distribution and water providers have been more resilient during this crisis, due to their strong revenue underpin based on existing regulations and limited operational impact observed so far

However, Covid-19 may still have an impact on these business through impacts on macroeconomic variables such as inflation, the financial markets and potential impact on future regulatory changes

Covid-19 impact on valuations of regulated utilities


• UK water RAB regime provides strong contractual protections leaving water companies relatively unaffected from a revenue perspective.

• Potential risk of bad debts from customers unable to pay water bills have not materialised.

• Business have continued to be able to operate their water networks effectively while respecting social distancing. UK water companies were categorised by Government as key workers, which enabled continuance of operations.

• Back office services (retail activity) continued to be provided with workers working from home.

• Short term impact on liquidity as volumes fell in the short term (due to lower B2B water consumption) only partly compensated by higher residential consumption.

• In general majority of businesses have strong cash reserves which have enabled them to remain unaffected.

• Also, lenders have proven ready to provide waivers on short term covenant issues.

• Labour party nationalisation risk disappeared after General election in December 2019.

• Updated regulation (FD19) published by Ofwat in December 2019 with negative impact on water companies.

• CMA (Competition and Markets Authority) appeal from 5 water companies in Q1 2020 - to be resolved in the next 6 to 12 months.

• Uncertainty around attitude of investors towards UK water following the above, rather than impact of Covid-19.

• No transactions involving water companies since South Staffordshire Water acquisition by Arjun Infrastructure in the summer of 2018.

Covid-19 impact on UK water Other valuation impacts in UK water

UK water sector

• Pre Covid-19, there was a pause in transactions from mid 2018 as investors waited for the outcome of the regulatory update FD19.

• Latest deals were the acquisition of South Staffordshire Water by Arjun and Affinity Water by HICL, still at significant multiples.

• Historically, following the completion of regulatory updates, we expect to see an uptick in transactions. However, this did not happen following FD19 due to the CMA appeal.

• Covid-19 has happened in the middle of the CMA appeal and therefore limited impact per se.

• There have been some rumours about certain water companies potentially being sold (Wessex Water) but nothing has come to fruition.

UK water transactions


80.0

90.0

100.0

110.0

120.0

130.0

140.0

150.0

Reb

ased

sha

re p

rice

(100

)

Regulated Water and Gas Providers

United Utilities Group PLC Pennon Group Plc Severn Trent Plc National Grid plc

Covid-19 UK water companies and National Grid share price impact

Despite the negative FD19 announced by Ofwat, and as a result of the UK election result reducing the risk of Labor party nationalization, share prices increased by an average of 9% between early and late December.

Over time, listed water and gas providers have recovered to levels close to those seen at the start of the year (small 1% reduction on average between early March and end of June).

Covid-19 declared a pandemic by WHO

UK election result

On 11/03/2020, the WHO declared Covid-19 a pandemic. Immediate UK market response was a general fall in share prices, although they quickly recovered and by the end of March the average reduction since 2019 year end was only c. 2%


• European regulated utilities market more limited in terms of size than UK.

• Typical European regulated utilities are gas and electricity distribution.

• Water typically contracted by public sector through concessions, whereas in the UK they are indefinite licences.

• Regulatory regimes vary in complexity and in in terms of the risks transferred to the private sector.

• RAB style regime is predominant but there are regimes with parametric formulas and incentives to grow connection points or efficiencies of networks.

• Given the strong protections offered by the regulations, Covid-19 has had a limited impact.

• In the last 3/4 years, there have been two key transactions in the Spanish gas distribution business, the sale of Madrilena del Gas (MRG) and Redexis.

• The Spanish gas distribution and transmission has gone under significant regulatory review in the last 12 months, which has had an impact on valuations.

• Apart from regulatory challenges, only impact seen in Spanish gas distribution and transmission was through delays in construction of new connection points due to restrictions imposed by Government in relation to Covid-19 / social distancing.

• Overall limited impact given strong protections of the asset class and valuation impacts also driven by regulatory changes.

Covid-19 impact on European assets

Example 1: Spanish gas distribution

European regulated utilities

• Most significant transactions pre Covid-19 were the Electricity North West (ENW) in the UK and Firmus gas distribution business in Northern Ireland, both of them at significant multiples.

• Following those deals, the transactions pipeline has been somewhat more limited but we do not attribute this to Covid-19.

• On 26 March 2020 (i.e. post Covid-19), Ardianacquired the German gas and electricity distribution business EWE.

• Other parties involved in the sale process where DWS, Swiss Life, PGGM, Macquarie, Allianz and IFM, which implies investors showing significant interest in the asset class post Covid.

• Current sale processes include the German regulated utility MVV (understood to have been acquired by First State in April 2020) and Galp’sPortuguese gas distribution business.

Transactions


Renewable energy assets


European Renewable Energy Share Price Performance

Source: CapitalIQ


-9%

-8%

-5% -5%

1%

-10%

-8%

-6%

-4%

-2%

0%

2%

% C

hang

e 20

20 v

s 20

19Global Energy Demand (2020 vs 2019)

Oil Coal Gas Electricity

Renewables

Source: IEA Global Energy Review

BloombergNEF has however lowered its previous forecast for new wind and solar installations this year by 12% and 8% respectively, due to the impact of the virus.


Future Electricity Price Trends

0

10

20

30

40

50

60

70

Ele

ctric

ity P

rice

€/M

Wh

Forecast electricity price Forecast electricity price with shock

Source: independent Energy forecast

General downward trend in electricity prices in recent years, with Covid-19 having potential for 5 year impact. ‘Captured Prices’ showing even greater negative impact (+10% in some European countries). Driving demand in assets with features to mitigate against merchant energy price exposure (subsidy, CPPA etc)


Renewable Energy Discount RatesPre-operation Post-operation

Onshore Wind

Offshore Wind

5% - 6.5%7% - 9.5%

8% - 10.5% 6% - 7.5%

Post-tax IRR

Renewable energy discount rates have held steady during Covid-19, with cashflow being main adjustment.Some downward energy price movement has been offset by other assumption changes (life extension).Argument for assets with high merchant exposure to have discount rate adjustment.

Source: KPMG Analysis


Other Covid-19 Valuation ImpactsImpact on financingWe are likely to see a reduced pool of liquidity availability for greenfield developments. Lenders may become increasingly more selective as to where they deploy their capital, which in turn will heighten the scrutiny on assets with merchant price risk.

Impact on auction and construction timelines

Because of lockdown measures, renewables auctions / offshore wind lease rounds have been delayed or postponed, and construction plans have been pushed back

Impact on O&M

Contractors may indicate that they cannot fully perform their maintenance activities. This may have material impacts on cash flow if this were to extend to certain unscheduled maintenance activities critical for the good continued operation of the assets.

Investor sentimentInvestment committees are challenging harder on whether equity discount rates can be increased, to reflect: (i) whether there is any lower potential competition for the assets; (ii) exploiting any potential asset issues as a reason to increase risk premium; (iii) more merchant exposure also increasing risk premium. However, new investment into renewables has continued throughout the crises even though execution takes longer.

Impact on insurancePandemics are generally not insurable events and the position from the insurance market at the moment seems to be to deny liability for all claims relating to COVID-19. However, the position is not yet certain and continues to be assessed by the market.

Impact on supply chainSupply of goods or equipment being produced elsewhere in Europe or Asia, due to restrictions on factory working and/or transport of goods. Measures are being taken to adjust shipping and delivery arrangements, which may have costs and delay implications for projects.


Conclusion


-40.0%

-35.0%

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

Volume Based Regulated Utilities PFI Availability Renewables

Valuation impact range and average by sector

Difference in KPMG’s private valuations pre and post Covid-19

Renewable energy funds have had some small negative impacts. However these are not being driven by Covid-19 (as discount rates have remained at pre-Covid low levels) but by the depressed power price curves across Europe.

The PFI funds have had some small negative impacts due to the small exposure of the funds to volume based assets (e.g. HICL) and the expected impact of Covid-19 on the refinancing markets.Covid-19 impact on volume

based assets valuations is significant with airports and toll roads being the most affected assets whereas resilient UK ports have seen a more limited impact.

Regulated utilities have remained broadly flat but there have been some significant negative impacts albeit not driven by Covid-19 and rather influenced by the significant regulatory changes being implemented by various European countries, e.g. UK water and gas and electricity distribution, Spain gas distribution and transmission.


Q&A

ema asset management’s valuation webinar series...china. developing economies (excl. china)...

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