MASTERS IN FINANCE EQUITY RESEARCH

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1 MASTERS IN FINANCE EQUITY RESEARCH E.ON AG UTILITIES SECTOR 12 NOVEMBER 2014 STUDENT: RITA MANTAS 9M Results in Line Strong operational results, albeit one-off tax effect Recommendation: HOLD Vs Previous Recommendation HOLD Price Target FY15: Facts: E.ON s announcement of 3Q14 results reported 9M14 EBITDA of 6,637m, 3% ahead of consensus and 7% below 9M13, and Adjusted Net Income of 1,435m in line with consensus and 25% below last year figure. E.ON closed down by 3.36%. Our Analysis: We forecast very solid 9M14 EBITDA owing to good performance of Generation, Renewables and EP. The former two turned out to beat our expectations in 3Q14. Networks in Germany and within Europe were in line with our forecasts, whereas Russia beat our expectations, despite 19% decline yoy. Adjusted Net income was greatly affected by the non-recurring effect of a deferred tax adjustment in 3Q14 (income tax rate from 29% in previous estimates, and 26% in 1H14, to 37% in 9M14). Vs Previous Price Target Price (as of 12-Nov-14) Reuters: EONGn.DE, Bloomberg: EOAN GR 52-week range ( ) Market Cap ( m) 25,073 Outstanding Shares (m) 2,001 Volume 7,843,820 Source: Bloomberg, Company data Market Performance Conclusion: Although FY14 guidance has been maintained and no much light was given for 2015, we changed our estimates to accommodate a full year tax rate of 37% with no further impact on later years and update sales volumes in Generation, Renewables and EP. We maintain our recommendation with a new PT FY15 of The main risks are, on the positive side, total reimbursement of nuclear shutdown costs by the German government; whereas, on the negative side, further depreciation of the rouble and weakening of commodities prices. Company description E.ON is one of the largest investor-owned energy companies in the world and the largest German utility listed in the German Stock Index (DAX) by market capitalization. E.ON was formed back in 2000 after the merger between VEBA and VIAG. In 2013, E.ON distributed more than 700 TWh of electricity and 1,000 TWh of gas. Its activities include conventional generation of fossil fuels, renewable energy, exploration and production of oil and gas (EP), trading global commodities and managing network connections in and outside Europe. Although Europe represents the primary market, E.ON has also expanded its operations to Russia, as well as Turkey and Brazil. EOAN GR Equity DAX Index SX6E Index Source: Bloomberg (Values in m) E 2015F Revenues 122, , ,998 EBITDA 9,315 8,425 8,452 Adj. Net Income 2,142 1,756 2,576 EPS DPS P/E EV/EBITDA EV/EBIT Net debt/ebitda ROA (%) ROIC (%) Source: Company data, Analyst s estimates See more information at Page 1/8

2 Recent developments 9M14 German energy consumption declined 6.7% yoy Fig.1 - First Year Baseload Forward Price Germany (EUR/MWh) Source: Bloomberg Macro data for the 9M14 German energy consumption reported a decline of 6.7% yoy (AG Energiebilanzen). The weak economic recovery in Europe, and globally, along with mild temperatures during the first months of 2014, as well as lower baseload power prices and regulatory changes, for instance in Germany, explain the lower margins obtained by companies within the Utilities sector in 9M14. An ongoing debate this year in Germany has to do with the Greenbook, which aims at discussing electricity market design options in Germany. Such initial draft is essentially a fundamental approach to whether Germany is better-off with a capacity market or a pure energy market; in other words, that a fundamental decision between an "energy only market 2.0" with fully flexible prices or a capacity market has to be taken. Still, it does not draw any conclusions that a capacity market is needed. According to the Conference Call, nothing has been decided and more information will be given in 2015 under a Whitebook on the matter. Overall, the paper calls for a temporary capacity reserve to deal with uncertainties in the market. Less fundamental issues, but more legal, German Utilities have filled for nuclear exit lawsuits over last months. Following the indication given by the German government to phase out nuclear power, this legal action is likely to have a large effect on E.ON s earnings, if the company succeeds in court. As for November 2014, the decision to phase out nuclear power in Germany has triggered 14 lawsuits by E.ON, RWE, EnBW and Vatenfall, according to the Environment Ministry. If companies do win in court, they will benefit from lower costs due to the decision by the German government of closing Nuclear Power Plants (NPP s) in the country. Impact on Forecasts and Valuation 3Q14 EBITDA ahead of expectations 9M14 EBITDA decline (7% yoy) reflect this mix of challenging market conditions As estimated, 9M14 EBITDA decline (7% yoy) reflects this mix of challenging market conditions in central Europe, exchange rate movements and regulatory pressures across all E.ON s business units. Nevertheless, the 3Q14 performance of Conventional Generation and Renewables beat our expectation in terms of PAGE 2/8

3 operational results, as well as for Global Commodities and Russia, where EBITDA was slightly ahead of our estimates. Positive impacts at EBITDA level: Fig. 2 EBITDA Development Source: Company data - As we forecast, Conventional Generation more than benefitted from the cost cutting plan E.ON 2.0, leading to lower operational costs and higher margins. 9M14 EBITDA was slightly above our forecasts (6%). Notwithstanding the positive impact from the early closure of the NPP Grafenrheinfeld, which lowered the nuclear fuel tax payment in Germany. - Likewise, Renewables reported higher than expected margins owing to higher hydro volume in Sweden, continuing operating efficiencies and asset rotation program in wind and solar. 3Q14 EBITDA grew more than 30% to 237m and 9M EBITDA by 12% yoy to 1,107m. Our estimates were 5% below the 9M14 figure. - EP s good performance was already set to continue from 1H14 until FY14 due to high production volumes from Skarv. Although we forecast higher EBITDA increase (35% yoy), EP s EBITDA increased by 26% to 942m in 9M14, maintaining the upward trend reported in 1H14. Negative impacts at EBITDA level: - Despite the huge decline in earnings FY14, 3Q14 results in Global Commodities revealed a better than expected performance. Nevertheless, 9M EBITDA went down by more than 50% yoy to 394m confirming the negative effect of both Foldgáz disposal and weakness in gas storage. In Germany, 9M14 EBITDA declined by 28% yoy in line with our expectations - In Germany, the distribution business profitability was compromised by tighter regulatory fees defined by the regulator. Also, as a result of last year disposals, 9M14 EBITDA declined by 28% yoy in line with our expectations. Fig.3 - EURRUB Source: Bloomberg - As for Other European Union regions, 9M14 EBITDA went down by 22% yoy to 1,336m as expected. Those regions were also negatively affected by regulatory measures, particularly, Czech Republic, and effects from warmer temperatures registered in 1H14. - As estimated, lower sales volume in Russia and foreign exchange rate depreciation weaken operating results for the quarter. Despite the lower 9M14 EBITDA reported (-19% yoy), 9M14 EBITDA was slightly ahead of our estimates by 1%, whereas 3Q14 beat our expectations by 4%, growing to 401m. PAGE 3/8

4 - According to the conference call held today, economic development below company s expectations and reduced economic outlook adversely affected both Brazil and Turkey earnings performance. Whereas in Brazil, issues over Power Purchase Agreements (PPA s) were a negative factor; in Turkey generation, supply and distribution activities have been more negatively affected than in Brazil. One-off tax payments and provisions charges Strong operational earnings reported in 3Q14 were offset by a higher than expected tax rate, which translated into a deferred tax adjustment in The resulting income tax rate of 37% over 9M14 earnings clearly deviates from E.ON s guidance of a long-term tax rate between 25% and 30%. Although the one-off effect relating to the change in the value of deferred taxes was not reported as exceptional and hence non-recurring, it impacted negatively net income only for the period. Nevertheless, it is regarded as a 2014 specific issue and a not cash effective item. Looking at provisions reported by the company, the discount rate used for pension obligations was cut by 140bp for Germany (to 2.50%) and by 60bp for the UK (to 4.00%). Although pension provisions increased due to lower discount rates, the other relevant effect was the additional 3.4bn to economic net debt, even if partly offset by the 1.9bn rise in the fair value of plan assets. Regarding nuclear asset provisions, management ensured that the company reports one of the highest values for nuclear provisions among its peers and that those provisions are reviewed on a yearly basis. The next revision will take place in 4Q14. Economic net debt to EBITDA is likely to remain at 3.5x in 2014 and 2015 Economic net debt for 9M14 is at 31bn. Although higher than in 1H14 due to the above mentioned effects, it is below the figure reported in 2013 of 32.2bn owing to asset disposals. Given the current macroeconomic scenario and financial overview of the company, we estimate that economic net debt to EBITDA is likely to remain at 3.5x in 2014 and Further concerns on 2014 outlook and beyond The outlook for 2014 was reiterated Despite a strong quarterly performance, the outlook for 2014 was reiterated: FY14 EBITDA between 8.0 and 8.6bn, whereas Adjusted Net Income between 1.5 and 1.9bn. No guidance was provided during the conference call for 2015 and it is unlikely to be announced until next year. PAGE 4/8

5 No guidance was provided for 2015 until next year Further asset disposals negotiations are still going on, namely, both Spanish and Italian assets held by E.ON. However, the company was not willing to comment on details regarding the sale of both stakes held in the subsidiaries. Moreover, according to the Interim Report and conference call, E.ON has fully hedged its central European power sales for 2015, approximately 48 per MWh, and 2016 ( 38 per MWh) compared to the 56 per MWh hedged for These values are below the current figure for 2014, which might be an indicator of further pressure on margins for Finally, although management does not perceive political and economic tensions in Russia as a threat to the company s earnings in the region, we believe that further devaluation of the rouble may compromise profitability of the business. Uncertainties regarding future economic and political situation in Russia may be a drawback in E.ON operating activities. EBITDA Breakdown m 3Q14A 3Q14E Dev. 3Q13A YoY 9M14A 9M14E Dev. 9M13 YoY Generation % % 1,553 1,467 +6% 1, % Renewables % % 1,107 1,058 +5% % Commodities Expl. & Prod , Total EP % % 1,336 1,328 +1% 1,608-17% Germany ,307 1,296 1,825 Other EU ,336 1,390 1,716 Total Networks % % 2,643 2,686-2% 3,541-25% Russia* % % % % Management (70) (186) +62% (206) -75% (341) (457) +25% (462) +35% E.ON EBITDA 1,624 1, % 1, % 6,637 6, % 7,117-7% * Russia EBITDA includes losses from operations in Brazil and Turkey. PAGE 5/8

6 Appendix Financial Statements From EBITDA to Net Income m 1H13A 1H14A YoY 9M14A 9M14E Dev. 9M13A YoY 2013A 2014E EBITDA 5,705 5,013-12% 6,637 6, % 7,117-7% 9,315 8,425 D&A (1,725) (1,770) -3% (2,725) (2,808) +2% (2,676) -2% (3,634) (3,492) EBIT 3,980 3,243-19% 3,912 3,597 +9% 4,441-12% 5,681 4,933 Financial results (912) (917) -1% (1,256) (1,094) -15% (1,312) +4% (2,475) (1,784) PBT 3,068 2,326-24% 2,656 2,503 +6% 3,129-15% 3,206 3,150 Income Taxes (888) (611) +31% (971) (714) -36% (893) -9% (703) (1,165) Minorities (273) (190) +30% (250) (375) +33% (329) +24% (368) (348) Net Income* 1,907 1,525-20% 1,435 1, % 1,907-25% 2,142 1,652 * Net Income attributable to E.ON shareholders and adjusted for income from discontinued operations. PAGE 6/8

7 m Income Statement 2012A 2013A 2014E 2015E 2016E 2017E Revenue 132, , , , , ,545 EBITDA 10,771 9,315 8,425 8,452 8,499 8,997 D&A EBIT (3,759) 7,012 (3,634) 5,681 (3,492) 4,933 (3,414) 5,038 (3,427) 5,072 (3,644) 5,353 Financial results (623) (2,475) (1,784) (1,662) (1,600) (1,602) EBT 3,274 3,206 3,150 3,376 3,472 3,751 Income Taxes Minorities (698) (424) (703) (368) (1,165) (348) (1,013) (375) (1,042) (379) (1,125) (367) Net Income* 2,189 2,142 1,652 1,989 2,052 2,258 Balance Sheet Fixed Assets 96,563 94,703 94,943 96, , ,953 WC Assets 28,325 26,099 25,248 23,596 22,158 22,252 Other Assets 15,538 9,923 9,923 9,923 9,923 9,923 Total Assets 140, , , , , ,128 Financial Debt 25,944 23,260 21,235 20,207 20,234 20,955 WC Liabilities 21,759 19,416 21,101 20,933 22,362 21,541 Provisions Other Total Liabilities Shareholders Equity Cashflows Statement 32,650 21,253 20,404 20,418 20,419 20,411 20, ,606 94,340 94,014 92,818 94,268 94,175 38,820 36,385 36,100 37,063 38,734 39,953 NOPLAT D&A Gross Op. CF Net CAPEX NWC Other changes Total Op. CF Non-Op. CF Total FCFF 5,192 3,759 8,951 (917) 2,631 (1,949) 8,716 (1,300) 7,416 4,236 3,634 7,870 1,193 (117) 1,181 10,127 (397) 9,729 3,233 3,492 6,725 (3,892) 2, ,440 (153) 5,287 3,527 3,414 6,941 (5,100) 1, ,325 (4) 3,321 3,551 3,427 6,977 (8,069) 2,867 (1) 1,775 (195) 1,580 3,747 3,644 7,391 (4,730) (915) 1 1,748 (212) 1,536 Interest paid (1,329) (1,823) (1,396) (1,265) (1,220) (1,217) Tax shield Net Debt (3,080) (3,508) (2,025) (1,029) Change in Equity (3,406) (4,945) (2,285) (1,401) (759) (1,406) Total Cash Flow from investors (7,416) (9,729) (5,287) (3,321) (1,580) (1,536) * Net Income attributable to E.ON shareholders and adjusted for income from discontinued operations. PAGE 7/8

8 Disclosures and Disclaimer Research Recommendations Buy Hold Sell Expected total return (including dividends) of more than 15% over a 12-month period. Expected total return (including dividends) between 0% and 15% over a 12-month period. Expected negative total return (including dividends) over a 12-month period. This report was prepared by a Masters of Finance student, following the Equity Research Field Lab Work Project, exclusively for academic purposes. Thus, the author, which is a Masters in Finance student, is the sole responsible for the information and estimates contained herein and for the opinions expressed, which reflect exclusively his/her own personal judgement. All opinions and estimates are subject to change without notice. NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report nor for any consequences of its use. The information contained herein has been compiled by students from public sources believed to be reliable, but NOVA SBE or the students make no representation that it is accurate or complete, and accept no liability whatsoever for any direct or indirect loss resulting from the use of this report or its content. The author hereby certifies that the views expressed in this report accurately reflect his/her personal opinion about the subject company and its securities. He/she has not received or been promised any direct or indirect compensation for expressing the opinions or recommendation included in this report. The author of this report may have a position, or otherwise be interested, in transactions in securities which are directly or indirectly the subject of this report. NOVA SBE may have received compensation from the subject company during the last 12 months related to its fund raising program. Nevertheless, no compensation eventually received by NOVA SBE is in any way related to or dependent on the opinions expressed in this report. The NOVA School of Business and Economics does not deal for or otherwise offers any investment or intermediation services to market counterparties, private or intermediate customers. This report is not an investment recommendation as defined by Article 12.º-A of the Código do Mercado de Valores Mobiliários. The students of NOVA School of Business and Economics are not registered with Comissão do Mercado de Valores Mobiliários as financial analysts, financial intermediaries or entities or persons offering any services of financial intermediation, to which Regulamento 3.º/2010 of CMVM would be applicable. This report may not be reproduced, distributed or published without the explicit previous consent of its author, unless when used by NOVA SBE for academic purposes only. At any time, NOVA SBE may decide to suspend this report reproduction or distribution without further notice. PAGE 8/8