Polenergia. Hold. There is still much that remains beyond the company s control

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1 EQUITY 30 May 2017 Electric Utilities 12m target downgrade Go to SG website There is still much that remains beyond the company s control Hold Price 26/05/17 PLN m target PLN13.2 Upside to TP 13.8% 12m f'cast div PLN m TSR 13.8% Main changes since last report Target (PLN) 13.2 (16.2) EPS 17e (PLN) (0.408) +40.1% EPS 18e (PLN) (0.461) -20.9% EPS 19e (PLN) (0.520) -26.8% new vs (old) nc: no change Preferred stock RWE GR, VIE FP, ELE SM, UN01 GR Least preferred stock N/A SG strategy team sector weighting Underweight Share price performance May Jul Sep Nov Jan Mar Perf. (%) 1m 3m 12m YTD Share Rel. index* Rel. sector** * MSCI World ($) ** MSCI World Utilities ($) Price RIC PEPP.WA, Bloom PEP PW 52-week range EV 17 (PLNm) 1,199 Mkt cap. (PLNm) 527 Free float (%) 14.9 No. shares o/s (m) 45 Avg vol. 3m (No. shares) 14,865 Equity analyst Bartlomiej Kubicki Specialist sales Sophia Hart We are cutting our EBITDA estimates to reflect lower green certificate prices and weaker performance in biomass and conventional generation. As a result, we lower our TP to PLN13.2 (was PLN16.2) and reiterate our Hold rating. The company is endeavouring to control opex, optimise property taxes and tap new business opportunities, but these efforts can only partially offset the negative regulatory regime. Low green certificate prices hit 1Q17 EBITDA Earnings are under pressure from alltime-low green certificate prices as a result of oversupply, limits on new wind farm capacity (coupled with a lack of visibility on future auctions) and rising property taxes on wind farms. As a result, 1Q EBITDA (reported 11/05/17) fell by 51% yoy to PLN43.2m, with opex cuts only partly absorbing the negatives, all of which is beyond the company s direct control. Hence, the relatively high leverage at >4x Net Debt/EBITDA at end-1q17. Change to estimates We cut our EBITDA estimates, as we incorporate lower green certificate prices assumptions (PLN30/MWh) with no visibility on a potential rebound. We believe the elimination of the Ex Officio Seller will expose to the volatility of spot power prices (from FY18). We also cut our estimates for the conventional generation business to adjust to a normalised 1Q17 EBITDA, cut our forecasts for the biomass business due to the low prospects of fuel price increases given the lack of biomass co-firing in Poland. We also mark to market the regulatory distribution WACC, which translates into lower EBITDA given the declining yields in Poland. Risks remain skewed to the upside but with little visibility We do not think green certificate prices can decline much more and we pencil in full property tax duties from FY18 on (in FY17 has managed to work in some optimisation). There could be some downward pressure on power prices (commissioning of new, more efficient conventional capacities, capacity market introduction) but on the other hand, is also positively biased towards higher CO2 costs and potentially rising coal prices in Poland (both via higher electricity prices). The non-core business (like the development of power storage projects) not to mention the offshore wind farm development portfolio could be value-accretive but offer limited visibility for now. Pressure on the development of renewables might pave the way for the State to ease regulations sometime in the future. Financial data 12/16 12/17e 12/18e 12/19e Ratios 12/16 12/17e 12/18e 12/19e Revenues (PLNbn) P/E (x) NM Rev. yoy growth (%) FCF yield (/EV) (%) EBIT margin (%) Dividend yield (%) Rep. net inc. (PLNm) Price/book value (x) EPS (adj.) (PLN) EV/revenues (x) EPS yoy growth (%) EV/EBIT (x) Dividend/share (PLN) EV/IC (x) Dividend yoy growth (%) NA NA NA ROIC/WACC (x) Payout (%) Net Debt/EBITDA (x) Societe Generale ( SG ) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that SG may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. PLEASE SEE APPENDIX AT THE END OF THIS REPORT FOR THE ANALYST(S) CERTIFICATION(S), IMPORTANT DISCLOSURES AND DISCLAIMERS. ALTERNATIVELY, VISIT OUR GLOBAL RESEARCH DISCLOSURE WEBSITE

2 Hit by an adverse regulatory regime Nothing new on the regulatory front, with the Polish government s frosty attitude towards renewable energy and wind farms in particular. Most the wind development projects have been scrapped on the back of the minimum-distance-from-household rules for new farms (10x the height of the wind turbine) and little visibility on future auctions. If there is no/very little new onshore wind between now and the end of 2018, most of the still-valid projects would have to be cancelled as the minimum distance rule would apply to them - projects are protected once they have had valid building permits for three years. Additionally, the property tax on wind farms has been increased significantly (now also applies to the wind turbine), which in the case of would increase the tax by some PLN22m p.a. on SGe. However, for 30% of its farms in FY17, has managed to secure the tax at earlier (lower) levels and for some farms, the tax increase has been reduced vs the total potential impact. Consequently, we expect the incremental tax impact to amount to PLN7m this year for. Last but not least, we have seen the development of green certificate oversupply (a legacy of over-compensating hydro generation and biomass co-firing prior to 2016) with a lack of willingness to increase the redemption obligation by electricity suppliers. The result is all-time-low green certificate prices (below PLN30/MWh), which not only hurt wind farms but have also stopped the co-firing of biomass and consequently affect s pellet production lines. Green certificate prices (PLN/MWh) Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Apr-17, POLPX All the aforementioned = weak 1Q17 For 1Q17, reported EBITDA of PLN43.5 (-50% yoy), EBIT of PLN18.7m (-69% yoy) and net income of PLN1.6m (-96% yoy). This was alongside green certificate prices declining on average by 70% yoy, lower power prices, higher taxes, subdued biomass production but an extended lifespan for the wind farms (from 20 to 25 years), which to some extent supported EBIT and net income (quarterly depreciation was lower by PLN5.3m in the wind segment). 30 May

3 : 1Q17 review PLNm 1Q17 1Q16 % yoy 4Q16 % qoq Comment Wind generation EBITDA % % 7.2% yoy decline in electricity production, 70% drop in green certificate prices (average POLPX), higher property taxes, repair costs for damaged wind turbines Conventional generation EBITDA % % Last year's performance was impacted by a positive LTC revaluation. We also note lower heat revenues this year (PLN6.5m vs PLN8.8m) despite a 9% increase in volumes Biomass EBITDA % % Lower volumes and prices Distribution EBITDA % % Normalisation of EBITDA Trading EBITDA % % Impact of green certificate prices. Otherwise, trading volumes are rising and also now trades CO2 TOTAL EBITDA % % D&A % % Increase in the wind farm lifespan from 20 to 25 years EBIT % N.A. Net income % N.A. Net debt % 736 0% Cash flow from operations of +PLN16.2m, Cash flow from investments of -PLN4.8m All the aforementioned = lower EBITDA estimates : macro assumptions e 2018e 2019e 2020e CO2 price (EUR/t) EUR/PLN Coal price (PLN/GJ) Clear dark spread (PLN/MWh) Baseload electricity price (PLN/MWh), 1Y forward Green certificate price (PLN/MWh) Our wind farm EBITDA increases for this year, which is the effect of the lower than previously assumed increase in the property tax impact (PLN7m vs PLN22m). However, we keep the full tax impact from FY18e onwards (for instance, municipalities that decided not to charge higher tax review such decisions on an annual basis). Lower green certificate price assumptions lead to lower wind farm EBITDA. We also cut our estimates for conventional generation (1Q17 was a normalised quarter and we also note the cheaper heat prices receives from Ciech), for biomass (lower production, lower prices) as well as our EBITDA estimate in the distribution segment (we mark to market our regulatory WACC estimates to the current level of 10Y sovereign yields). We also incorporate a fine-tuning factor into our planning model. From FY18, the regulations relating to the so-called Ex Officio Seller will be abolished. Under these regulations, wind farms have been able to sell electricity to the utilities (their supply arm) at prices pre-determined by the regulator. Consequently, buyers were exposed to uncertain electricity volumes to be purchased at higher than spot prices at a time when wind conditions were very good (usually depressing power prices; Energa is one of the most exposed companies to the existence of such regulations, see our last report here). From FY18, wind farm operators will be exposed to spot prices. In simple terms, they will be exposed to lower-than-average prices when their load factors increase (1Q, 4Q) and higher spot prices when load factors (and hence 30 May

4 production) is lower than the average annual load factor (2Q and 3Q). Our simplistic model shows a loss of c.4% on average in the realised power price for wind farms. On the other hand, however, lower depreciation charges (increased lifespan of the operating wind farms from 20 to 25 years) offset part of the negative EBITDA revision at the net income level. : old and new estimates (PLNm) Revenues 2017e 2018e 2019e New 2,954 2,993 3,041 Old 2,891 2,934 2,980 % 2.2% 2.0% 2.1% EBITDA 2017e 2018e 2019e New Old % -5.8% -13.0% -12.6% Wind farm EBITDA 2017e 2018e 2019e New Old % 19% -7% -8% Conventional generation EBITDA 2017e 2018e 2019e New Old % -12% -12% -12% Distribution EBITDA 2017e 2018e 2019e New Old % 0% -3% -6% Biomass EBITDA 2017e 2018e 2019e New Old % -51% -52% -53% Net income 2017e 2018e 2019e New Old % 40% -21% -27% 30 May

5 Hold reiterated a stock with a lot of upside potential but with low visibility Regulatory change in Poland Our calculations indicate that almost all wind farms located in Poland with project financing and 70% of debt in the funding mix should not be able to meet their debt obligations (interest payments and principal repayments). This is assuming a 30% load factor, full property tax payment, a PLN160MWh electricity price and a PLN30/MWh price for green certificates. In other words there is a systemic problem (note that this does not apply to wind farms owned by state-controlled utilities with lower funding costs incurred at the corporate level rather than the project level). In light of this, we could not rule out adverse regulations (on property taxes as well as green certificate redemption obligations) changing at some stage to support the near-bankrupt businesses. Offshore projects has secured the environmental green light for two of its farm projects totalling 1.2GW, with construction targeted to start in 2020 for the first 600MW and 2023 for a further 600MW. We have no visibility on the support system for offshore yet, but we assume that with the state-owned PGE working on its own offshore project, we would not rule out offshore developing further within the Polish power network. Wind farm life extension has extended the lifespan of its wind farm assets to 25 years from 20 (we have already assumed the operating life of the farms at 25 years and from now on only extend the depreciation life to 15 years). However, as SG equity analyst Jorge Alonso wrote in his Deep dive into supply and renewables lifespan report, many big renewable developers have already adopted longer lifespans of 30 years (vs 25 years previously) for wind assets. Thanks to technological advances, this extension seems feasible, in our view. Gamesa was the first turbine manufacturer to certify a wind turbine life extension to 30 years. Hypothetically, if we assume is able to extend the life of its newest capacities (i.e. the 99MW commissioned in 2015), we would expect the valuation of the company to increase by 3.5% on SGe. New businesses aims to expand its business into PV and energy storage. The company has signed an MOU with Convergent Power (a US Storage developer which develops, owns and operates energy storage assets) to identify storage projects in Poland, Germany, Austria, Switzerland and Italy for a start. Furthermore, has also signed an MOU with Solar Century on PV developments and, as a pilot project, has submitted a bid for a 6MW PV hybrid project for a gold mine in Namibia under a long-term off-take. We expect to find out more about these potential development avenues in 3Q/4Q17 when the company plans to announce its strategy. 30 May

6 Poland subject to risks of not meeting 2020 EU renewable energy targets Ecofys recently published a paper on Poland that said the country would probably not meet its 15.5% RES target in 2020 if it continues with the current conditions for RES deployment (i.e. support policies in place and announced for the period). Under the optimistic scenario, it is estimated that Poland would miss its 2020 RES target by at least 791 ktoe and under the pessimistic assumptions that gap would increase up to 3,556 ktoe. In terms of the share of renewables in total energy consumption, this translates into 10%-13.8% of the overall RES share in Consequently, the consulting company sees Poland requiring significant additional investment and incentives to meet the targets. Ecofys: Poland s RES targets Source: Ecofys, Valuation : SOP valuation (PLN/share) Wind farms old RES regime Wind farms new RES regime ENS, other PEP, distribution Off-shore wind farms Gas pipeline project Net debt Value per share 30 May

7 Sales/division 16 EBIT/division 16 Sales/region 16 Major shareholders (%) Electricity sales 80.3% CHP 9.2% Wind 4.9% Distribution 4.0% Others 1.6% Others 184.8% Wind 76.3% Electricity sales -5.4% Distribution -24.5% CHP % Poland 100.0% Kulczyk Investments 50.2 CEE Equity 16.0 Aviva OFE 6.7 Valuation (PLNm) 12/12 12/13 12/14 12/15 12/16 12/17e 12/18e 12/19e No. of shares basic year end/outstanding Share price: avg (hist. yrs) or current Average market cap. (SG adjusted) (1) 1,196 1,270 1,250 1, Restated net debt (-)/cash (+) (2) Value of minorities (3) NA NA NA NA NA NA NA NA Value of financial investments (4) Other adjustment (5) EV = (1) - (2) + (3) - (4) + (5) 1,285 1,438 1,620 2,054 1,459 1,199 1, P/E (x) NM Price/cash flow (x) NM Price/free cash flow (x) NM NM Price/book value (x) EV/revenues (x) EV/EBITDA (x) Dividend yield (%) Per share data (PLN) SG EPS (adj.) Cash flow Book value Dividend Income statement (PLNm) Revenues 132 1,118 2,659 2,757 2,997 2,954 2,993 3,041 Gross income EBITDA Depreciation and amortisation EBIT Impairment losses NA NA NA NA NA NA NA NA Net interest income Exceptional & non-operating items NA NA NA NA NA NA NA NA Taxation Minority interests Reported net income SG adjusted net income Cash flow statement (PLNm) EBITDA Change in working capital Other operating cash movements Cash flow from operating activities Net capital expenditure Free cash flow Cash flow from investing activities Cash flow from financing activities Net change in cash resulting from CF Balance sheet (PLNm) Total long-term assets 482 1,253 1,968 2,448 2,271 2,234 2,150 2,055 of which intangible Working capital Employee benefit obligations NA Shareholders' equity ,333 1,396 1,267 1,293 1,309 1,326 Minority interests Provisions Net debt (-)/cash (+) Accounting ratios ROIC (%) ROE (%) Gross income/revenues (%) EBITDA margin (%) EBIT margin (%) Revenue yoy growth (%) NM NM Rev. organic growth (%) EBITDA yoy growth (%) NM EBIT yoy growth (%) NM NM EPS (adj.) yoy growth (%) Dividend growth (%) NA NA NA NA NA NA NA Cash conversion (%) nm 88.3 nm nm nm nm nm Net debt/equity (%) FFO/net debt (%) Dividend paid/fcf (%) NM NM NM NM NM NM NM NM 30 May

8 APPENDIX Report completed on 30 May :54 CET COMPANIES MENTIONED CIECH (CIE.WA, No Reco) Endesa SA (ELE SM, Buy) Energa (ENG PW, Buy) Gamesa Corp Tecnologica (GAM SM, Buy) (PEP PW, Hold) Polska Grupa Energetyczna (PGE PW, Hold) RWE (RWE GR, Buy) Uniper (UN01 GR, Buy) Veolia Environnement (VIE FP, Buy) ANALYST CERTIFICATION The following named research analyst(s) hereby certifies or certify that (i) the views expressed in the research report accurately reflect his or her or their personal views about any and all of the subject securities or issuers and (ii) no part of his or her or their compensation was, is, or will be related, directly or indirectly, to the specific recommendations or views expressed in this report: Bartlomiej Kubicki The analyst(s) who author research are employed by SG and its affiliates in locations, including but not limited to, Paris, London, New York, Hong Kong, Tokyo, Bangalore, Frankfurt, Madrid, Milan, Seoul and Warsaw. Historical Price: (PEPP.WA) 2014/2015 Change 2016/2017 Change (Paris time) /02/15 New Rating: Buy 18/02/16 New Target: /02/15 New Target: /08/16 08:00 New Rating: Hold 13/05/15 New Target: /08/16 08:00 New Target: /11/15 New Target: /11/16 07:23 New Rating: Buy 10/11/16 07:23 New Target: /02/17 07:07 New Rating: Hold 24/02/17 07:07 New Target: /14 04/14 07/14 10/14 01/15 04/15 07/15 10/15 01/16 04/16 07/16 10/16 01/17 04/17 Price Target MA100 Change Reco VALUATION METHODOLOGY AND RISKS TO RATING, RECOMMENDATION AND PRICE TARGET Valuation Methodology Our SOTP of PLN13.2 comes predominantly from the valuation of windfarms (EV of PLN17.0/share) and other activities driven by conventional generation (EV of PLN10.7/share), which is adjusted by net debt per share of PLN16.2. We use a WACC of 5.4% for the windfarms segment and a WACC of 6.2% for other activities. Risks Upside risk: a) higher green certificate prices - a PLN10/MWh increase would have a valuation impact of PLN1/share); b) more visibility on the development of the wind farms segment in Poland (auctions, offshore); c) clarity on the increase in property tax on wind farms - should the increase not apply, our TP would go up by PLN5 all else remaining constant. Downside risks: a) lower green certificate prices - a PLN10/Mwh decrease would have a valuation impact of PLN1/share, b) rising interest rates ( has net debt of PLN740m, most of the debt is WIBOR-linked; c) a decline in power prices predominantly on the elimination of the ORM mechanism (lower clean-dark spreads) and/or rising efficiency of coal plants in Poland. 30 May

9 SG EQUITY RESEARCH RATINGS on a 12 month period BUY: absolute total shareholder return forecast of 15% or more over a 12 month period. HOLD: absolute total shareholder return forecast between 0% and +15% over a 12 month period. SELL: absolute total shareholder return forecast below 0% over a 12 month period. Total shareholder return means forecast share price appreciation plus all forecast cash dividend income, including income from special dividends, paid during the 12 month period. Ratings are determined by the ranges described above at the time of the initiation of coverage or a change in rating (subject to limited management discretion). At other times, ratings may fall outside of these ranges because of market price movements and/or other short term volatility or trading patterns. Such interim deviations from specified ranges will be permitted but will become subject to review by research management. Sector Weighting Definition on a 12 month period: The sector weightings are assigned by the SG Equity Research Strategist and are distinct and separate from SG equity research analyst ratings. They are based on the relevant MSCI. OVERWEIGHT: sector expected to outperform the relevant broad market benchmark over the next 12 months. NEUTRAL: sector expected to perform in-line with the relevant broad market benchmark over the next 12 months. UNDERWEIGHT: sector expected to underperform the relevant broad market benchmark over the next 12 months. The Preferred and Least preferred stocks are selected by the covering analyst based on the individual analyst s coverage universe and not by the SG Equity Research Strategist. Equity rating and dispersion relationship % Updated on 02/05/17 43% % % 22% 50 23% 0 Buy Hold Sell Companies Covered Cos. w/ Banking Relationship All pricing information included in this report is as of market close, unless otherwise stated. MSCI DISCLAIMER: The MSCI sourced information is the exclusive property of Morgan Stanley Capital International Inc. (MSCI). Without prior written permission of MSCI, this information and any other MSCI intellectual property may not be reproduced, redisseminated or used to create any financial products, including any indices. This information is provided on an as is basis. The user assumes the entire risk of any use made of this information. MSCI, its affiliates and any third party involved in, or related to, computing or compiling the information hereby expressly disclaim all warranties of originality, accuracy, completeness, merchantability or fitness for a particular purpose with respect to any of this information. Without limiting any of the foregoing, in no event shall MSCI, any of its affiliates or any third party involved in, or related to, computing or compiling the information have any liability for any damages of any kind. MSCI, Morgan Stanley Capital International and the MSCI indexes are service marks of MSCI and its affiliates or such similar language as may be provided by or approved in advance by MSCI. IMPORTANT DISCLOSURES SG and its affiliates beneficially own 1% or more of any class of common equity of Veolia Environnement. SG and/or its affiliates act as market maker or liquidity provider in the debt securities of Energa, RWE, Veolia Environnement. SG and/or its affiliates act as market maker or liquidity provider in the equities securities of Endesa SA, Gamesa Corp Tecnologica, RWE, Uniper, Veolia Environnement. SG or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from RWE, Veolia Environnement. SG received compensation for products and services other than investment banking services in the past 12 months from Endesa SA, Energa, Polska Grupa Energetyczna, RWE, Uniper, Veolia Environnement. SGAS had a non-investment banking non-securities services client relationship during the past 12 months with RWE, Uniper. SGAS received compensation for products and services other than investment banking services in the past 12 months from RWE, Uniper. FOR DISCLOSURES PERTAINING TO COMPENDIUM REPORTS OR RECOMMENDATIONS OR ESTIMATES MADE ON SECURITIES OTHER THAN THE PRIMARY SUBJECT OF THIS RESEARCH REPORT, PLEASE VISIT OUR GLOBAL RESEARCH DISCLOSURE WEBSITE AT or call +1 (212) in the U.S. European Specialty Sales 30 May

10 If a European specialist sales personnel is listed on the cover of research reports, these employees are in SG s Global Markets division responsible for the sales effort in their sector and are not part of SG s Cross-Asset Research Department. Specialist Sales do not contribute in any manner to the content of research reports in which their names appear. SG has mandatory research policies and procedures that are reasonably designed to (i) ensure that purported facts in research reports are based on reliable information and (ii) to prevent improper selective or tiered dissemination of research reports. The analyst(s) responsible for preparing this report receive compensation that is based on various factors including SG s total revenues, a portion of which are generated by investment banking activities. Non-U.S. Analyst Disclosure: The name(s) of any non-u.s. analysts who contributed to this report and their SG legal entity are listed below. 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