Snam Rete Gas & Terna

Transcription

1 Snam Rete Gas & Terna Growth and visibility fully discounted - Initiating coverage at Neutral We initiate coverage of Snam Rete Gas with a Neutral rating and a 12-month RAB-based DCF PT of Snam s regulation allows for meaningful value creation from new investments and we expect capex momentum to accelerate significantly in However, we expect the 2009 regulatory review to continue the pass-through of efficiency gains to clients, placing a cap on the medium term growth outlook for the group. Terna, Snam s electricity sibling, has just had a mildly positive regulatory review, but in our view this is already largely priced in. We expect Terna s domestic capex momentum to accelerate moderately in the next few years and growth to be increasingly reliant on higher-risk international expansion. We initiate coverage of Terna with a Neutral rating and a 12-month RABbased DCF PT of Near term, however, we would expect both stocks to outperform the sector, as their respective strategic updates (13 February and 31 January) could trigger small upgrades in estimates. We prefer the Spanish network companies Red Electrica and Enagas (both OW). Italian network companies enjoy superior regulatory visibility at this stage, but we expect the gap to be substantially narrowed when the new remuneration model to new capex in Spain is approved (which we expect to happen in the next few weeks). At that stage the superior growth prospects for Spanish networks should support outperformance versus their Italian peers. Table 1: Valuation comparison for Southern European network companies Snam Terna Red Electrica Enagas Share price Target price % upside potential 6.9% 4.2% 24.4% 28.6% Dividend yield 2008E 5.1% 5.4% 3.2% 3.5% EV/EBITDA 2008E 9.7x 9.9x 10.4x 10.4x EBITDA CAGR % 6.9% 11.1% 11.0% Source: Datastream, JPMorgan estimates. Priced at COB 18 January. Price target are 12-month, RAB and DCF-based. SRG.MI Neutral January 2008 Price Target: 4.90 TRN.MI Neutral January 2008 Price Target: 2.95 Utilities Javier Garrido AC Chris Rogers (44-20) christopher.g.rogers@jpmorgan.com Sofia Savvantidou, CFA (44-20) Sofia.Savvantidou@jpmorgan.com For Specialist Sales advice, please contact: Ian Mitchell (44-20) ian.e.mitchell@jpmorgan.com Snam Rete Gas Price Performance Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 YTD -1M -3M -12M Absolute 4.8% 2.9% 0.3% 4.4% Terna Price Performance Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 YTD -1M -3M -12M Absolute 0.9% 0.2% 4.9% 8.3% Source for both charts: RIMES, Reuters. J.P. Morgan Securities Ltd. See page 41 for analyst certification and important disclosures, including investment banking relationships. JPMorgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm 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. The analysts listed above are employees of either J.P. Morgan Securities Ltd. or another non-us affiliate of JPMSI, and are not registered/qualified as research analysts under NYSE/NASD rules, unless otherwise noted.

2 Table of Contents Investments thesis...3 Capex requirements...3 Stable regulation...3 We see more value in the Spanish networks...3 Key dynamics in the Italian energy sector...4 Does the Italian energy sector require new investments?...4 Regulatory framework...9 Snam Rete Gas...11 The company...11 Regulated revenues...12 Capex profile...17 Financial estimates...19 Valuation...22 Terna...26 The company...26 Regulated revenues in Italy...27 Brazilian revenues...31 Capex profile...31 Financial estimates...32 Valuation...35 Company Data Price ( ) 4.58 Date Of Price 18 Jan week Range ( ) Mkt Cap ( bn) 8.1 Fiscal Year End Dec Shares O /S (mn) 1,760 Snam Rete Gas S.p.A. (SRG.MI;SRG IM) 2006A 2007E 2008E 2009E 2010E EBITDA FY ( mn) 1,383 1,433 1,545 1,585 1,562 EV/EBITDA FY Adj. EPS FY ( ) Adj P/E FY Dividend (Gross) FY ( ) Gross Yield FY 4.6% 5.1% 5.3% 5.4% Headline EPS FY ( ) NAV/Sh FY ( ) Source: Company data, Reuters, JPMorgan estimates. Company Data Price ( ) 2.83 Date Of Price 18 Jan week Range ( ) Mkt Cap ( bn) 5.7 Fiscal Year End Dec Shares O/S (mn) 2,000 Terna - Rete Elettrica Nazionale S.p.A. (TRN.MI;TRN IM) 2006A 2007E 2008E 2009E 2010E EBITDA FY ( mn) ,026 1,086 EV/EBITDA FY Adj. EPS FY ( ) Adj P/E FY Dividend (Gross) FY ( ) Gross Yield FY 4.9% 5.2% 5.4% 5.7% 5.9% Headline EPS FY ( ) NAV/Sh FY ( ) Source: Company data, Reuters, JPMorgan estimates. 2

3 Investment thesis We initiate coverage of Snam Rete Gas and Terna with Neutral ratings. We believe that the share prices of both stocks largely reflect their virtues as defensive stocks and the visibility of their regulatory frameworks. We can see some very near term potential for outperformance vs the sector as we expect both companies to deliver a solid message in their strategic presentations (on 13 February and 31 January respectively) and to upgrade their medium term capex targets. However, after such initial reaction we would expect a period of undistinguished performance by both stocks. Our RAB-based DCF 12-month price targets are 4.90 for Snam Rete Gas and 2.95 for Terna. Capex requirements Medium and long term projections indicate moderate electricity and gas demand growth in Italy. Such a scenario would suggest that limited new investments are required in infrastructure. However, this is not correct in our view. Snam is expected to face a significant (and sustainable) escalation in capex requirements to connect the new infrastructures for gas imports into the Italian market (both pipeline and LNG) as well as to adapt the Italian network to the incremental flows required by the development of an active spot market (required if Italy wants to fulfill its ambition to become a European gas hub). Meanwhile Terna needs to make substantial investments to connect to the network the new more modern thermal plants that should replace ageing oil-fired capacity as well as the substantial additions of wind renewable energy capacity. Besides, Terna is highly incentivised to invest in eliminating the bottlenecks in the Italian network and we expect such investments to accelerate in the next few years. Stable regulation The Italian regulator has now a long tradition of maintaining a remuneration model based on an allowed return on investments, with medium term incentives to growth capex and encouraging operating efficiency. The recent regulatory review of the electricity network business has reinforced our view of high visibility and stability in the Italian regulatory model. We see more value in the Spanish networks As Table 1 shows, the Spanish and the Italian network companies are trading at similar EBITDA multiples when projected EBITDA growth for the Spanish operators is substantially above that of their Italian counterparts (due to the fact that proportionally the capex requirements for the Spanish utilities are even superior to those of Snam and Terna). We believe that this valuation anomaly is due to the far superior visibility of the Italian regulatory framework. However, we expect the Spanish government to approve in the next few weeks a new remuneration model for the capex to be invested in the next 9 years by Red Electrica and Enagas. Such approval would significantly reduce the visibility gap between the two regulatory regimes and is the reason for our preference for the Spanish networks versus their Italian peers. 3

4 Key dynamics in the Italian energy sector We are anticipating a sustainable increase in the capex requirements for both Snam Rete Gas and Terna in the next few years despite the outlook for modest growth in electricity and gas demand in Italy. These views are largely based on our expectation that the sources of gas will be materially diversified in the next 6 years and that the electricity network will need to be adapted to higher efficiency requirements and to the connection of new gas-fired and renewable energy capacity. We expect the regulator to provide a stable regulatory framework in this period of significant investment. Does the Italian energy sector require new investments? New investments required in the gas sector As we have described in the past (see Southern European utilities - It s me, the regulator, I am back, from 22 November 2007) the Italian energy market lacks sufficient sources of gas to promote real competition. The following factors are among the most important sources of inflexibility in the market: The oligopolistic status of the market, with a clear dominance of the Eni group. Despite the apparent efforts to reduce Eni s market share, still 65% of the gas injected in the Italian gas pipelines has been injected by the Eni group. Figure 1: Volumes injected by Eni in the Italian gas system bcm 58 75% 56 70% 54 65% 52 60% 50 55% % Source: Snam Rete Gas Volumes (bcm) Market share (rhs) The low flexibility of a gas system where less than 4% of the supplies come via LNG (and where therefore only storage facilities with 20bcm of capacity provide real flexibility). 4

5 Figure 2: Italian gas supply mix bcm Pipeline imports Domestic production LNG imports Source: JPMorgan estimates, Company data. The growing reliance on imports due to the steady decline in domestic gas production, from a very limited number of origins, and in an environment of a very tight supply and demand balance. Figure 3: Sources of gas imported into the Italian market bcm Source: Snam Rete Gas Algeria Russia North Europe* Liby a LNG In order to address the inefficiencies generated by all these inflexibilities the sector requires substantial investments so that: Energy players other than Eni can inject more gas into the Italian market. More LNG capacity is available in the market, as LNG is the main source of potential flexibility in gas supplies, while a substantial exposure to LNG should allow a convergence of Italian gas prices with the prevailing gas prices in the Atlantic basin. Other countries can supply gas to Italy, not just promoting competition, but also increasing the security of supply in the Italian market. 5

6 Additionally the Italian government has stated its aspiration that Italy becomes a hub for the entry of gas into the European markets. In order to fulfill such aspiration the Italian gas system needs to operate with sufficient spare capacity, so that it can deal with the requirements from other European markets as well as to allow the operators to set up a meaningful spot market based on not just virtual, but also physical exchanges of gas volumes. After many years of waiting, in our view the Italian gas market is about to go through a radical transformation, with 2 new pipelines bringing 16bcm of additional gas and at least 3 new LNG regasification stations to be built in the next 6 years. These new plants, together with the extension of the existing plant in Panigaglia, should add 24bcm of importing capacity into Italy. If we include on-going capacity extensions of the existing pipelines, in total Italy is set to increase its import capacity by 43-46bcm by 2013, versus an estimated 18bcm increase in consumption. Therefore the supply & demand balance will then be much more flexible, with a diversification of sources of gas and with more flexible LNG supplies (and we are not including yet the Taranto 8bcm LNG project, which in our view could also be commissioned by ). Figure 4: New sources of gas into the Italian market +8bcm +4.5bcm +3.5bcm +8bcm +8bcm Source: JPMorgan estimates, Snam Rete Gas +8bcm +3bcm Such radical transformation of the sources of gas imports into Italy will require in our view a substantial amount of investment into the Italian gas system, to connect the new points of entry to the network, to cope with the changes in the way gas flows inside the country and to allow for the system to operate with the required spare capacity for a liquid spot market to come gradually into operation. Is there a similar need for new investments in electricity? The Italian electricity system started its transformation at the end of 90s and since the beginning of this decade we have contemplated the gradual shift from a significant reliance on oil-fired capacity into a more efficient generation mix, where CCGTs play a dominant role and with a growing presence of renewable energies. 6

7 We expect the efficiency improvements in the dynamics of the Italian electricity sector to continue to materialize in the next few years. Addition of new, more efficient thermal capacity. With 21GW of CCGTs under operation and 10.3GW under construction as at 30 September 2007, we feel fairly confident that our estimates of capacity additions to 2012 are easily achievable. In fact, our estimates are a shade below Snam Rete Gas s, which looks for 34GW of CCGTs in We expect such a number in 2011, as we believe that the building process will be affected by the bottlenecks in the supply chain given the very strong demand that turbine manufacturers are facing on a worldwide scale. Although the risk profile of projections for new coal capacity is substantially bigger, given the significant local opposition to such projects, we are expecting 4.35GW of modern coal-fired capacity (with thermal efficiency factors in the low to mid-40s) to come on stream in the period Figure 5: Estimated installed capacity in CCGTs in Italy GW E 2003E 2004E 2005E 2006E 2007E 2008E 2009E 2010E 2011E 2012E Source: JPMorgan estimates. New renewable energy capacity. While the lack of visibility around the sustainability of the green certificate system has been holding back the development of the wind farm industry in Italy, the very attractive returns that could potentially be earned in the sector have gradually allowed the wind farm capacity additions to gain momentum. The network companies do not only need to invest in connecting the specific wind farm to the grid (an investment which is mostly made by the local distributor), but they also need to ensure that the system is ready to respond technically to the challenges of this source of generation (large amounts of capacity unavailable at the same time and at very short notice, voltage dips, geographical dispersion, etc). The latter investment requirements are addressed by the transmission operators. 7

8 Figure 6: Italian wind farm installed capacity MW 9,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1, E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E Source: EWEA, JPMorgan estimates. Reducing the bottlenecks in the network. Traditionally the South of Italy has faced a lack of investment in the electricity sector that has resulted in substantial bottlenecks (both in its connection with the rest of the country and among its different sub-regions). This situation would have been exacerbated in the next few years, as a significant proportion of the new generation projects are being built in the southern regions. New investments are being planned not just to make the new capacity commercially available in the country, but also to eliminate the price difference in the wholesale market between the northern and the southern regions (a testimony of the insufficient domestic interconnection capacity). New interconnections. Italy is a very well interconnected electricity market, as the country, particularly since the shutdown of the nuclear capacity in the 80s, has been traditionally a very sizeable net importer of electricity. However, the construction of new, more efficient thermal capacity, is gradually changing the status of Italy. While it should stay as a net importer of electricity, the net inflows should gradually diminish, as the new thermal capacity should sell a growing amount of output into foreign markets at mid-merit and peak hours. This requires investments in order to adapt the network to the new flows of electricity (the system was adapted to make the electricity low from the interconnectors to the areas of demand, not from the generation sites to the interconnectors). Besides, new interconnectors are being built (Sardinia-mainland Italy) or upgraded (Greece), while there are projects for additional new interconnectors through the Adriatic Sea connecting with Croatia (feasibility study already under way) and Albania (at a much earlier stage of development). 8

9 Regulatory framework The Autorita per l energia elettrica e il gas (AEEG) is the Italian regulatory authority that regulates and controls the electricity and gas sectors. The AEEG was set up on 4 December 1996 and it has been fully operational since 23 April The AEEG is an independent body and it enjoys a high degree of autonomy. Its regulatory powers include the setting of tariffs and the definition of service quality standards and the technical and economic conditions governing access to the networks for those services where market dynamics would not allow to adequate protection of the interests of users and consumers. When describing its objectives the AEEG mentions the following for tariffs: establishing a transparent and reliable tariff system based on pre-defined criteria. The tariff system is required to reconcile the economic and financial goals of electricity and gas operators with general social goals, and with environmental protection and the efficient use of resources. In our view the AEEG has to a large extent achieved its targets of transparency and reliability for the regulatory framework. The regulation of both electricity and gas transmission is built on the basis of an allowed return to the investments made by the different players (a RAB-based system) and the regulatory parameters are reviewed every 4 years. The main guidelines for both sectors would be the following: The existing assets at the start of the first regulatory period (initial RAB) should be allowed a headline return in line with the estimated cost of capital of the companies. The new investments should be allowed a premium return in order to promote the execution of those new investments. The AEEG has improved materially in its definition of the incentives for new investments in its various regulatory reviews and seems to be aiming at average premiums of 2% to 3% over WACC for average periods of 10 to 12 years. Promotion of efficiency gains. In the 3 years between the reviews, the companies operate under price cap mechanisms where the operators are allowed to pass through to clients their costs, but are also incentivised (CPI-X formulae) to achieve efficiency gains and to beat the regulatory standards as they can keep 50% of the opex outperformance for the next regulatory period. The regulator is also gradually (and rightly in our view) evolving to a system where the price cap is only applicable to the real opex (and not to the depreciation allowance) and where one-off and non-manageable costs get a special, differentiated treatment. Figure 7: Basic outline of Italian regulatory system RAB x Return on investments = Allowed return (including premium returns to new investments) + Source: JPMorgan Depreciation allowance + Opex allowance (incl 50% of previous efficiency gains) = = Total allowed revenues 9

10 The current 4-year period for Snam Rete Gas covers the period from 1 October 2005 to 30 September 2009 (based on gas years) and the regulation was approved on 5 August We would expect initial discussions between the company and the regulator for the new regulatory period to start in October 2008 and a first consultation document to be released around April/May The AEEG has just approved (29 December 2007) the rules for the current 4-year regulatory period for the electricity networks and dispatching businesses (1 January December 2011). In the next sections we describe the regulatory framework for each company. Recent change in the corporate tax rate The Italian Parliament finally approved in the last few days of December a government proposal that implements an aggressive tax reduction for Italian corporates. While the impact of the headline tax reduction is partially offset for some Italian companies by the elimination/reduction of some of their tax deferrals and tax deductions, for Snam and Terna the reduction implies a full benefit, as they did not enjoy a significant amount of tax shields in their domestic operations. For both companies the effective tax rate in their domestic operations should fall from c. 40% in 2007 to approximately 35-36% in Figure 8: Implication of recent tax changes in Italy Previous regulation New regulation Effective Effective IRES: 33% IRES: 27.5% IRAP: 4.25% c. 40% IRAP: 3.90% c. 35% Source: JPMorgan estimates. IRES: National corporate tax, based on pre-tax profits. IRAP: Regional corporate tax, based on adjusted operating profits. The reform also means that the companies will have to pay in the future a lower amount of taxes that those booked as deferred taxes in their balance sheets, as the tax rate applicable to those future tax payments should be lower than previously expected. This should result in a one-off non cash tax gain in the 2007 results. 10

11 Snam Rete Gas Neutral Current price: 4.58 Price target: 4.90 Snam Rete Gas operates in a regulatory environment that allows for meaningful value creation from new investments. We expect the momentum in capex to accelerate from 2008 onwards and the higher capex level to be sustainable for at least the next 8 years. We would expect the shares to outperform near term when such acceleration in capex is confirmed on the strategic update scheduled for 13 February, eventually driving the stock closer to our price target of However, we expect the 2009 regulatory review to continue the pass-through of efficiency gains to the customer, placing a cap on the medium term growth outlook for the group. Hence our Neutral rating on the stock. The company Origin Snam Rete Gas is the almost-monopolistic operator in the transport and dispatching of natural gas in Italy (market share of 98%+) and owns the only LNG re-gasification plant in operation in the country (a situation that is due to change soon). Created on November 15, 2000 by receiving the activities of transport and dispatching of natural gas as well as the re-gasification of LNG from Italian oil giant Eni, Snam became operational on July 1, The company has been listed on the Italian Stock Market since December 6, Top management The top management of the company is integrated by: Alberto Meomartini, Chairman Carlo Malacarne, Chief Executive Officer Francesco Iovane, Managing Director Operations Antonio Paccioretti, Chief Financial Officer Most of the career of all the top management of Snam has been developed at the Eni group. Company Data Price ( ) 4.58 Date Of Price 18 Jan week Range ( ) Mkt Cap ( bn) 8.1 Fiscal Year End Dec Shares O /S (mn) 1,760 Snam Rete Gas S.p.A. (SRG.MI;SRG IM) 2006A 2007E 2008E 2009E 2010E EBITDA FY ( mn) 1,383 1,433 1,545 1,585 1,562 EV/EBITDA FY Adj. EPS FY ( ) Adj P/E FY Dividend (Gross) FY ( ) Gross Yield FY 4.6% 5.1% 5.3% 5.4% Headline EPS FY ( ) NAV/Sh FY ( ) Source: Company data, Reuters, JPMorgan estimates. 11

12 Dimensions The Snam Rete Gas transmission system consists of approximately 30,889 km of natural gas pipelines (as at 31/12/2006) with a diameter from 25 to 1,400 mm and a pressure between 0.5 and 75 bar. Ten compression plants dedicated to line pressure service are part of the network, along with gas regulation, reduction and mixing plants and other plants necessary for the transport and dispatch of gas. For administrative purposes the Snam Rete Gas natural gas pipelines have been divided into two parts: the first belonging to the National Gas Pipeline Network, for a total of 8,479 km. and the second to the Regional Gas Pipeline Network, for the remaining 22,410 km Figure 9: Snam Rete Gas network Source: Company reports Snam owns (via GNL Italia) the only existing LNG re-gasification plant in Italy, in Panigaglia. The terminal has two 50,000 cubic metre storage tanks and has a total capacity of 3.6bcm. Regulated revenues As we mentioned above, the AEEG approved the remuneration model for Snam s 2 nd regulatory period (Oct 2005-Sept 2009) in August To better understand Snam s regulated revenues we should split the total revenues into 3 categories: Revenues from opening RAB. Revenues from development capex in the first regulatory period. Revenues from new investments 12

13 Revenues from opening RAB The opening RAB was calculated as the aggregation of the initial RAB in 2001 plus the cumulative investments made in (including work in progress and working capital at the end of 2004) minus the depreciation and disposals made in the period. All the figures were updated by inflation (the deflator of gross investments, rather than the CPI). The result was an opening RAB of 10.66bn. The allowed return was calculated based on what at the time were tough assumptions, particularly due to the low beta (0.56x levered) and the relatively high proportion of debt assumed in the capital employed (41.18%). The result was a 6.7% headline return (real, pre-tax). As a result the allowed return on the opening RAB was 714m. Figure 10: Derivation of allowed rate of return for gas transmission Source: Snam Rete Gas The depreciation was calculated assuming a 36 year average useful life for the assets, which is in line with their expected average technical life.the result was a depreciation allowance of 498m. Last, but not least, the opex allowance was calculated by the aggregation of the actual opex for 2004 (the last FY before the review) plus 50% of the cost savings achieved versus the opex allowed for 2004 according to the remuneration model for the first regulatory period (which, in our view, was based on generous assumptions). The result was a theoretical opex allowance of 341.7m. Theoretically, then, the remuneration for the opening RAB in the first gas year of the 2 nd regulatory period was 1,554m ( 714m + 498m + 342m). Theoretically? Yes, this is just the initial calculation, because the regulator wanted to leave some exposure to volumes for the company and also allow for some revenue outperformance due to the fact that the efficient design of the network allowed to cope with incremental gas volumes minimizing the required investment. 13

14 As a result, the regulator divided the remuneration to the opening RAB into 2 different components: Capacity reference revenue: 70% of the remuneration to the opening RAB was included in this category. This portion has no exposure to the volume effect and therefore the capacity revenue for the opening RAB in year 1 was simply 70% of the total theoretical revenue or 1,088m (70% of 1,554m). Commodity reference revenue. This portion of revenues has exposure to the volume factor via the following mechanism: the remaining 30% of the theoretical revenues to the opening RAB (ie 466m) were divided by the reference volumes set by the regulator at 79.1bcm and the resulting unit revenue was multiplied by the actual volumes injected into the network in gas year 1 (87.3bcm). As a result the actual commodity revenue was 514m. Besides, capacity and commodity reference revenues are updated during the other 3 years of the second regulatory period according to different mechanisms. Update of the capacity reference revenue. To make things even more complex, the regulator divided the capacity revenue into two sub-components, which were updated according to different formulae. Capacity return: The portion of the capacity component that is attributable to its share of the allowed return (ie 70% of 714m) is updated every year based on the evolution of the opening RAB (ie subtracting every year the annual depreciation of the opening RAB) and updated the final result by inflation. Capacity opex + depreciation: The reminder of the capacity component is updated based on a revenue cap formula of CPI 2%. Update of the commodity reference revenue. Fortunately, the update of this factor is a simple price cap formula, where the unit revenue is updated every year according to CPI 3.5%. Figure 11: Estimated remuneration for opening RAB Opex Depreciation Allowed return m 1,800 1,600 1,400 1,200 1, Theoretical y r-1 Real yr-1 Real y r-2 Real y r-3 Real y r-4 Source: JPMorgan estimates, Company data. Capacity return Capacity opex + depr Commodity rev enues Revenues from development capex in the first regulatory period In the first regulatory period there was also an incentive to make new investments (development capex) which was calculated in a totally different way by the regulator. The premium was aggregated in a commodity component (which was defined 14

15 differently versus the commodity component of this regulatory period) and this premium is still to be paid for a period of 6 years after the first year when the capex was added to the regulatory asset base. The calculation of the unit revenue in the first year of the second period was based on the theoretical gas volumes of the first year of the first regulatory period. Therefore it allows for a substantial volume outperformance, but on a small amount of money. The result is that thanks to this volume effect the theoretical revenues of 50m became 59m in year 1. Figure 12: Revenues for development capex from 1st regulatory period in year 1 of the 2nd regulatory period Source: Snam Rete Gas The evolution of these revenues during the rest of the second regulatory period is based on the evolution of the volumes (and also based on when the asset has been incorporated to the asset base for 6 years, which is the moment when the premium return is lost). Revenues from new investments (RNI) The regulator differentiated six categories of assets in which new investments could be made and allocated different premium returns to each of them. T1: Maintenance. T2: Safety, quality and market support. T3: Development of regional network. T4: Development of national network. T4: Development of national network for import. T6: Development of entry capacity at border. The difference lies not only in the magnitude and the duration of the incentives, but also on whether the associated opex is immediately recognized by the regulator or if Snam needs to wait until the next regulatory review. 15

16 Figure 13: Revenues from new investments in year 1 Source: Snam Rete Gas How are the revenues of the new investments updated in years 2-4 of this regulatory period? Again the regulator differentiates between allowed return, depreciation and opex. Allowed return. Updated based on the depreciation of the asset and adjusted by inflation. Depreciation allowance: Subject to a CPI X% revenue cap (with X being 2%). Opex (for T5 and T6): Based on actual costs. Summary The following chart shows our projections for the evolution of revenues in the 2nd regulatory period. Figure 14: Estimated revenues in the 2nd regulatory period m 1,850 1,800 1,750 1,700 1,650 1,600 1,550 1,500 1,450 1, E E E E Revenues from opening RAB Revenues from development capex Revenues from new investments Source: JPMorgan estimates. 16

17 In our projections for the 3rd and subsequent regulatory periods we assume that the regulator maintains the same regulatory structure as in the 2nd regulatory period. Pass through of exceptional costs One of the permanent complaints of Snam Rete Gas in the last few years was that there were operating costs that were recovered based on the price cap formula, but whose evolution has nothing to do with the evolution of inflation and that are not manageable by the company. The most relevant component of these costs is the fuel gas required for the operation of the compression stations. We estimate that between FY2004 (the last FY before the last regulatory review) and FY 2007 the fuel costs associated to the management of the transport network have increased from 37m to 79m. Finally in 2007, after very long delays, the regulator has accepted that the fuel cost of compression stations becomes a pass-through item in the fees charged by Snam. Besides, the regulator has allowed Snam Rete Gas to recover approximately 58m of past fuel costs from years 2005 and Theoretically Snam should have started to recover this shortfall in Q4 2007, but the regulation had not been instigated at that point. We expect extra revenues of 7m per quarter in the next 8 quarters to allow Snam to recover this shortfall. Snam is also aiming at recovering the extra cost of the network losses that is not contemplated by the regulator at present, but the recognition of that extra cost has made far less progress with the regulator and in the end this is a small amount of money, just 5m per annum according to our calculations. Capex profile Figure 15: Estimated long-term gas demand in Italy Source: Snam Rete Gas 17

18 Snam management is very conservative in our view and we believe this is best reflected in the capex projections of the group. Snam does not include any investment project into its capex plan until it has all the approvals from the different operators and regulatory bodies. In fact, Snam does not include into its projections even its own projects until they get full approval by the authorities. This for example means that the m expansion of the capacity of the Panigaglia LNG re-gasification plant planned by Snam, is not included into Snam capex plan even though the company aims at bringing this new capacity into operation in Such a conservative approach forces the group to give very near term (for the usual standards of network companies) capex targets of just 4 years, which limits the visibility of the long term projections for the group. As we explained in the previous section we are anticipating a very significant increase in the capex required in the Italian gas system, well above the amount of capex requirements suggested by simply looking at the top line gas demand growth. Although it is disappointing to see that Snam is not willing to participate in any LNG regasification project excluding the expansion of its existing plant in Panigaglia, still the company should make all the required investments in the expansion of the highpressure gas pipeline network in Italy. This is starting to be reflected by the company in gradual increases in the capex plans as the traditional 4-year target is rolled forward. Figure 16: Estimated evolution of Snam's 4-year capex plans February 2006 February 2007 February 2008E Capex plan Capex plan Capex plan bn 4.2bn 4.6bn Source: JPMorgan estimates, Company data. On 13 February Snam should update investors on its strategy and we expect the new 4-year capex plan to amount to bn, an increase simply due to the roll forward of the plan from to We are not expecting management to change its habits and provide a longer term outlook for capex, but we would expect strong hints at the potential for an investment run rate of 1-1.1bn to be sustainable for at least the next 8 years. We would expect consensus to show a mildly positive reaction to any reassurance by management of the sustainability of the high yearly capex, as the regulation that we have just described allows for sizeable value creation with the new investments. The chart below shows our medium term capex projections for Snam. We suspect that the risk to our estimates beyond 2011 is on the upside, but we are unlikely to have extra visibility that far out in the next 12 months. It should be noted that the investments made in year X start to be remunerated from 1 October of year X+1. 18

19 Figure 17: Snam Rete Gas - Estimated medium term capex m 1,400 1,200 1, E 2008E 2009E 2010E 2011E 2012E Source: JPMorgan estimates, Company data. T1 T2 T3 T4 T5 T6 Financial estimates Regulated revenues in Italy make up 99% of the projected revenues of Snam Rete Gas, as the non regulated revenues are marginal excluding one-offs. After the recognition by the regulator of the fuel cost for compression stations as a pass-through cost, the evolution of the variable costs line is largely irrelevant, because more than 80% of these costs will be automatically passed through to the customers (close to 95% once network losses are included). There should a sizeable increase in charges by third parties (from 21m in 2007E to 38m in 2009E) associated with the commissioning of the Rovigo re-gasification plant in H We are expecting a drop of controllable fixed costs (under Snam s definition) in real terms at least until 2010, a testimony of Snam s efficient operating standards. Figure 18: Estimated evolution of Snam's controllable fixed costs 1.0% 0.0% -1.0% E 2008E 2009E 2010E 2011E 2012E -2.0% -3.0% -4.0% -5.0% -6.0% -7.0% Source: JPMorgan estimates, Company data. 19

20 The main driver of such drop is the continued headcount reduction, as the company gradually approaches its ideal size. There is also an on-going contention in services by third parties (particularly in materials and maintenance). Note that the headline fixed costs should be inflated in 2008 by a one-off of 5m due to the accelerated depreciation of a pipeline. As we indicated above we are expecting the next regulatory review to follow the same guidelines of the last review in 2005, with the only exception of a slight increase in the estimated headline allowed return from 6.7% to 6.9% to bring it in line with the recently approved allowed return for Terna. As a result we are estimating a 3.9% CAGR in Snam s EBITDA in the 5-year period We are expecting the cost of debt for Snam to stabilize at 4.25% from 2008 onwards (versus 3.7% in 20069, reflecting that c. 50% of Snam s debt is contracted at fixed rates and 9% is paying an inflation-indexed rate). As we indicated in the initial section the drop in the corporate tax rates agreed in Italy at the end of 2007 should result in the effective tax rate for Snam to fall to c. 35% on a sustainable basis. Besides, we are estimating a one-off positive non-cash tax revenue in 2007, which should reflect the lower future tax obligations (as the effective tax rate on the net tax deferrals on the balance sheet should be c. 35%, rather than the previously estimated c. 40%). Table 2: Snam Rete Gas Profit & Loss Account m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Group revenues 1,778 1,791 1,927 1,976 1,960 2,082 2,197 - Regulated business 1,737 1,778 1,914 1,962 1,946 2,068 2,183 - Non regulated Group EBITDA 1,383 1,433 1,545 1,585 1,562 1,675 1,782 YoY % Change -4.7% 3.6% 7.8% 2.6% -1.5% 7.3% 6.4% Depreciation EBIT ,052 1,079 1,041 1,140 1,230 Net financial costs Pre-tax, pre-extraordinaries profit Tax Effective tax rate (%) -39.7% -24.9% -35.2% -35.2% -35.3% -35.3% -35.4% Reported Net Income Reported EPS YoY % Change -15.7% 34.0% -3.6% 0.8% -7.7% 9.6% 7.7% Recurrent Net Income Recurrent EPS YoY % Change -15.7% 0.3% 19.6% 0.8% -7.7% 9.5% 7.7% Gross DPS CFPS Source: JPMorgan estimates, Company data. Cash flow and balance sheet We expect Snam Rete Gas to stay FCF negative pre dividend payments at least until 2013, while we would not expect to see positive FCF post-dividends until 2017 at the earliest. 20

21 Table 3: Snam Rete Gas Cash Flow Statement m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Net income for the period Depreciation and write-downs Change in provisions Deferred taxes and interests Other non-monetary items Cash flow from operations ,013 1,072 Working capital variation Capex ,025-1,144-1,150-1,188-1,125 Dividends/buybacks Free cash flow Source: JPMorgan estimates, Company data. Table 4: Snam Rete Gas Balance Sheet and Key Ratios m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Net fixed assets 9,527 9,737 10,271 10,911 11,544 12,199 12,774 Net working capital Net tax liabilities Staff benefit fund Other liabilities Capital employed 8,954 9,164 9,698 10,339 10,971 11,626 12,202 Shareholders funds 3,699 3,366 3,455 3,517 3,521 3,559 3,625 Net financial debt 5,255 5,799 6,243 6,822 7,450 8,067 8,577 Net Debt/Equity 142% 172% 181% 194% 212% 227% 237% Net Debt/Capital Employed 59% 63% 64% 66% 68% 69% 70% Net Debt/EBITDA EBITDA interest cover Interest cover ROE 11.5% 12.5% 15.5% 15.3% 14.0% 15.2% 16.1% ROCE (pre-tax) 10.1% 10.4% 11.1% 10.8% 9.8% 10.1% 10.3% BV/share Source: JPMorgan estimates, Company data. Outlook for the dividend Snam management has committed to an 11% DPS growth per annum in 2007 and Given that we are anticipating a revenue contraction in the gas year as a result of the 3rd regulatory review, we would expect the dividend growth for the 4 years after the stated target to be just marginally above inflation (3% p.a.). What will Snam do with its treasury stock? Snam holds 195.5m of its own shares (9.9% of the total shares) as treasury stock. Management has not yet decided whether those shares will be cancelled or if they will be used to finance acquisition opportunities. In our projections we are assuming that those shares are cancelled. The decision should be taken by Snam management after the regulatory review of 2009 (ie in Q at the earliest). The potential acquisition opportunities that Snam would consider would always fall under the category of regulated energy network assets. The opportunities that were discussed in the past were the gas storage business of Eni (Stogit) and its distribution business (Italgas). However, these options seem to have low probability to materialize, as Eni does not appear to be keen to reduce its exposure to such businesses. 21

22 Meanwhile, we struggle to identify in the next 2 years meaningful acquisition opportunities overseas that fall under the requirements of Snam (fully regulated businesses that offer at least a similar return to its growth investments in the Italian network) and therefore allocate very low probability to overseas expansion in the near term. A merger of Snam and Terna? Last, but not least, Snam s treasury stock could be used to facilitate an integration of Snam and Terna. However, such a deal could be simply arranged as a merger of equals and is unlikely to require any payment for the shares of Terna, particularly given that the main attraction of such a deal would be the incremental size of the merged entity. An integration of Snam and Terna would yield modest cost synergies in our view (a maximum of 30m) and these would likely be shared with customers, ultimately. The merit would then be the construction of a larger company that would be better protected against `potential hostile foreign predators in the long term and that could play a more active role in the very long term consolidation of the European energy networks (a move that is actively sponsored by the Italian government but which is not enthusiastically welcome by other EU governments). While the topic of an integration of Snam and Terna sponsored by the Italian government has lost momentum (there used to be frequent calls from several MPs for the Parliament to propose the project officially to the government, but this is not the case now), it could come back at any time in the next few months. However, given the modest expected synergies and our expectation that a nil-premium merger is the most likely way for the integration to be completed, we would not get excited about the stocks if the merger momentum were to accelerate during Valuation Our valuation of Snam uses the RAB of its regulated business as a basis and then adds/subtracts the NPV of the different estimated operating, financial and fiscal estimated out/underperformances. We reach at 12-month price target of Table 5: Snam Rete Gas - Summary valuation Activity Estimated value ( m) Basis Reference RAB end 2008 WACC outperformance 686 NPV if divergent this & next 3 regulatory periods Incentivised return 1,414 NPV from capex in this & next 3 regulatory periods Operational outperformance 429 NPV including volume effect NPV deferred tax -327 NPV Transmission business 15, % premium to RAB LNG business 109 Similar premium as transmission Non-regulated 76 7x EV/EBITDA 2008E Enterprise value 15,226 Net debt -6,528 Debt required for end 2008 Other financial liabilities end 2008 Equity value 8,664 Shares end 2008 Price target ( ) end 2008 Source: JPMorgan estimates. 22

23 The RAB and the net debt To calculate our fair value and price target for Snam we use an adjusted value of the RAB and of the net debt. For the RAB we adjust the value estimated at the end of 2008 to factor in that this RAB will only start to get remuneration from 1 October 2009 onwards (ie that there is a 9-month delay for Snam to get the remuneration to the investments made). The impact is included in our calculation of the WACC out/underperformance. We also adjust the value of net debt on the balance sheet at the end of 2008 to take into consideration the fact that Snam usually pays for the capex accrued in Q4 of every year during the first quarter of the following year (ie we aim at factoring in the real financing required by the investments that make up the RAB of the reference year). This is meaningful if we use 2008 as the basis for valuation in Snam, as it is the year when the investments are due to accelerate significantly. WACC outperformance In our view the aggressive re-gearing conducted by Snam in the last 2 years has paid off and now the company s financial structure allows Snam to enjoy a very competitive cost of capital and therefore beat the regulator s (demanding) allowed return on RAB of 6.7% re-tax real. Taking into consideration the expected evolution of net debt in the next 10 years (Snam should stay FCF negative post dividends during this period), we estimate a WACC post-tax nominal of 5.2% for Snam, or 5.9% real-pre-tax. Given that in the Terna regulatory review the regulator allows the company to enjoy premium returns for the next 12 years, in our base-case scenario we are assuming that Snam will be allowed to beat the allowed return also for 12 years (3 regulatory periods) after the end of the current period. Table 6: Snam Rete Gas - Estimated WACC Risk free rate (nominal) 4.30% Market risk premium 4.0% Beta levered 0.75 Cost of equity 7.3% Cost of debt (pre-tax) 4.25% Tax shield 27.50% Cost of debt (post-tax) 3.08% Gearing = D/(D+E) 50.9% WACC nominal post-tax 5.2% Corporate tax rate 35.3% Inflation 2.00% WACC (real, pre-tax) 5.9% Source: JPMorgan estimates. Incentivised returns We are assuming that Snam Rete Gas will be allocated the same structure of incentivised returns again for the next 3 regulatory periods. We are also assuming a smilar spread of investments between the T1 and the T6 category. 23

24 Operational outpeformance We include here the value of: The traditional opex outperformance (ie the NPV of the extra cost cutting achieved by Snam versus the regulatory assumptions, assuming that the company can keep only 50% of the outperformance in the following regulatory period). The extra revenues derived from the usage by the regulator of a base level of estimated gas volumes that is below the actual levels of gas injected in the network (which results in a higher fee per cubic meter than would otherwise be the case). We also include the NPV of the recovery of the overrun in 2005 and 2006 in fuel costs for compression stations. Risks to our rating and price target, and valuation sensitivities Clearly the main risk to our rating and price target is that of adverse regulatory decisions, particularly if they were to be implemented via shock tariff cuts or other one-off regulatory decisions that were to jeopardize the margins of the company. However, the Italian regulator has proven to be very reliable in defending a sustainable, visible remuneration model based on allowed returns and, as explained above, is also improving in the recognition of the right of recovery of one-off costs by the company. The regulator has also proved to be helpful at times of uncertainty arising from regional government decisions (particularly when the Sicilian government attempted to implement a significant tax on Snam and the regulator made it clear that the extra cost would be recovered if the tax were not to be ruled illegal by the courts, as it was in the end). Another uncontrollable risk would derive from a significant delay in the building of new gas import infrastructure in Italy. However, as we argued in the previous section, we believe that the risk of lower-than-expected capex in the next 5 years is low, because several projects have made substantial progress in the last 12 months (expansion of existing pipelines, Galsi, IGI) and because Snam management is very prudent when setting up its capex targets for the medium term. Table 7: Key valuation sensitivities Variable Our assumption Flex Valuation effect /share WACC outperformance Allowed during 3 extra regulatory Not possible post periods review Incentivised returns Allowed to the capex of the next 3 Incentives to all future 0.55 regulatory periods capex Operational 50% pass-through of opex gains No volume benefit post outperformance and volume outperformance retained in future reviews 2009 review 12-year capex projection 10.2bn in E 10% higher 0.15 Source: JPMorgan estimates. 24

25 Will Eni sell its stake in Snam? Two years ago we thought that Eni would be forced by the government to sell down its 50.5% stake in Snam sooner rather than later, in a similar move to that in which Enel was forced to dispose of most of its shares in Terna. However, and despite the constant calls from the regulator demanding such disposal so that the gas sector is unbundled to favor competition, Eni successfully lobbied (in an environment of incremental protectionism towards the domestic utilities in many EU governments) to get a change in legislation, so that it no longer faces a fixed deadline to make such disposal. Under the current legislation Eni would have two years to complete the disposal of its stake in Snam once the government has published a decree that sets up the legal framework for such privatization (Eni is 30% government owned). Apparently the Italian government shares Eni s views that the spin off of Snam should now be completed only once the EU has set up a framework that forces the separation of the transmission companies from the vertically integrated utilities all across the EU. Given the resistance of key European countries like France or Germany against such forced separation (a requirement well beyond the currently required functional separation of activities within the groups), we would be very surprised if such regulation were to be passed any time soon. Therefore we do not anticipate any change in the shareholding of Eni in Snam unless the above-mentioned potential merger of Snam and Terna is completed. 25

26 Terna Neutral Current price: 2.83 Price target: 2.95 We see scope for Terna to upgrade its 5-year capex plan to 3bn+, therefore allowing for extra value creation as the recent regulatory review has confirmed the incentive-based scheme for new capex for the next regulatory period (4 years). Such upgrade plus incremental cost-cutting in its Italian operations and the benefits from the integration of the recent acquisitions in Brazil are likely to trigger some near term outperformance vs the European sector around the time of the strategic update of 31 January 2008, eventually taking the stock closer to our fair value of After this, we expect additional growth to be increasingly reliant on higher-risk, less visible international expansion, while the dividend CAGR beyond 2008E is expected to be just 4%. The company Origin Terna is the Transmission System Operator (TSO) and the principal owner of the Italian National Transmission Grid for high voltage electricity, holding 98% of the national electricity infrastructures. Terna was spun off from Enel in 2004 and the company has been listed in the Italian Stock Market since June 23, In 2005 Terna acquired the transmission operation, dispatching and metering activities of the former market operator GRTN, which allowed the company to effectively unify ownership and operation of the transmission assets on November 1, In 2006 Terna acquired the transmission assets of Edison and AEM Milan and in 2007 the company purchased the transmission assets of local utility Iride, bringing its market share of the transmission network from 92% to 98.3%. Abroad, Terna controls Terna Participaçoes (Terna Par), a company listed on the Sao Paulo Stock Exchange since October This is the holding company through which Terna operates in the electricity transmission sector in Brazil. Terna started operations with two concessions for transmission lines, TSN and Novatrans, transferred by Enel at the time of the spin-off and has been increasing its market share in the Brazilian transmission business with the acquisition of different local operators: Munirah (2006), Gtesa and Patesa (November 2007), 52.6% of ETAU (December 2007) and ETEO (expected to be completed in H1 2008). Company Data Price ( ) 2.83 Date Of Price 18 Jan week Range ( ) Mkt Cap ( bn) 5.7 Fiscal Year End Dec Shares O /S (mn) 2,000 Terna - Rete Elettrica Nazionale S.p.A. (TRN.MI;TRN IM) 2006A 2007E 2008E 2009E 2010E EBITDA FY ( mn) ,026 1,086 EV/EBITDA FY Adj. EPS FY ( ) Adj P/E FY Dividend (Gross) FY ( ) Gross Yield FY 4.9% 5.2% 5.4% 5.7% 5.9% Headline EPS FY ( ) NAV/Sh FY ( ) Source: Company data, Reuters, JPMorgan estimates. 26

27 Top management Luigi Roth, Chairman. Mr Roth is Deputy Chairman of Cassa Depositi e Prestiti, Terna s largest shareholder with a 30% stake. He was appointed chairman of Terna on November 2, Flavio Cattaneo, CEO. Mr Cattaneo s most prominent roles before he took his position in Terna were those of Deputy Chairman of AEM Milan and General Manager of the Italian Public Boadcaster RAI. He was appointed CEO of Terna also on November 2, Fabio Todeschini, CFO of Terna since Dimensions In Italy Terna owns and operates almost 40,000km of transmission lines (c. 50% are 380kV and 220kV and the rest are below 150kv), 358 transforming and switching stations and 3 tele-operation centers. In Brazil Terna Par is the second private company in terms of market share in transmission. It owns 2,821 km of transmission lines. With the acquisition of ETEO the network will grow by 502km. Regulated revenues in Italy The AEEG has just approved the remuneration model for Terna's 3rd regulatory period (January December 2011). Although the technical annexes with the details of the new regulation have not been released yet by the regulator, the outlook for the regulated revenues is already very visible. The recent regulatory review has brought a substantial improvement in the visibility and clarity of the remuneration system of Terna. One of the biggest improvements has been seen in the dispatching and measuring services. In the past Terna has been remunerated for these services with amounts equal to costs incurred for necessary services such as reserve, balancing and congestion resolution; however, there was little visibility on which were those necessary costs. Now these activities will be fully remunerated with the RAB-based system, with revenues split between the remuneration to the transmission RAB and to the RAB of dispatching. Calculation of the regulatory asset base The rules for the calculation of the RAB for tariff purposes are very clear and straight-forward. Transmission RAB tariff yr t = RAB end yr t-3 + Net investments yr t-2 + Deflator last 4Q Therefore the RAB that will be taken into consideration for the calculation of the revenues in 2008 will be the RAB at the end of 2005 plus the net investments made in 2006 (net of disposals and assets fully depreciated) and this figure will be updated by the deflator of investments (as published by the National Institute for Statistics) of the last 4 available quarters. In the end this means that the time lag between the moment when an investment is made and the time when it starts to be remunerated is an average of 18 months (this mechanism will in our view consolidate the trend of concentrating the most significant investment effort every year in Q4). 27

28 The initial RAB of the 3rd regulatory period is 6.1bn. According to our estimates this includes the market value of the assets that Terna has been acquiring in the Italian transmission sector in the last 2 years. Dispatching RAB tariff yr t = RAB end yr t-3 + Net investments yr t-2 The initial RAB of the 3rd regulatory period is 0.18bn. Figure 19: Estimated evolution of RAB in the 3rd regulatory period m 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 RAB for 2008 RAB for 2009E RAB for 2010E RAB for 2011E Source: JPMorgan estimates, Company data. Transmission Dispatch Allowed return on investments The initial RAB at the end of the 2nd regulatory period and all the maintenance investments are remunerated in line with the estimated WACC pre-tax real of Terna. For the allowed return decided by the regulator is 6.9%. Given that the technical annexes of the regulation have not been released yet, the derivation of this allowed return that we show in the figure below is based on our estimates and on the second consultation paper on the new regulatory framework that was elaborated by the regulator on 30 November Table 8: Estimated derivation of allowed return WACC Risk free rate (nominal) 4.41% Market risk premium 4.0% Beta levered 0.75 Cost of equity 7.4% Cost of debt (pre-tax) 4.90% Tax shield 27.50% Cost of debt (post-tax) 3.55% Gearing = D/(D+E) 44.4% WACC nominal post-tax 5.7% Corporate tax rate 35.0% Inflation 1.70% WACC (real, pre-tax) 6.9% Source: JPMorgan estimates. 28

29 Incentivised returns Another area where clarity has improved significantly is the sustainability of the premium returns to new incentivised investments. In the 2nd regulatory period the development capex (basically those investments different from maintenance and renewal investments) were allocated a 2% premium return, but the regulator had not disclosed the duration of such premium return. In the review the regulator has ruled that those premium returns on the development capex spent in the period will be kept until 31 December This means that those investments will get premium returns for a period of 11 to 14 years (depending on when the investment was made), which is at the upper part of our previous expectations (which looked for an average duration of 10 to 12 years). The incentives for development capex in the 2nd regulatory period are very clear: I3 investments, which are those made to reduce congestions in the network (including in the borders) will get a 3% premium return for a 12 year period. I2 investments, which includes all the other development capex, will get a 2% premium return for 12 years. All the RAB of the dispatch business, including new investments, will be remunerated at the headline 6.9% return pre-tax real return. Terna estimates that c. 50% of its development capex will fall under the I3 category. Based on this assumption we estimate that the achieved return on the new investments to be made in the period will be 8.6% pre-tax real. Figure 20: Estimated effective returns on new investments 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Headline return Return for I2 inv estments Return for I2 inv estments Return capex in Source: JPMorgan estimates. Opex and depreciation allowance The opex allowance of 2008 is going to be based on the actual opex of Terna in 2006 increased by the volume growth in 2007 and by the 50% of the opex outperformance versus the regulatory target achieved by Terna in

30 Allowed Opex = Actual Opex 2006 x (1+ Volume growth 2007 ) + 50% of efficiency gains. This is the new reference figure for 2006, which is updated with the price cap formula (CPI-X) to make it the actual allowed opex for The X of the price cap formula for transmission has been cut from 2.5% to 2.3%. The X factor for dispatch is just 1.1%. We estimate that the average blended X factor for opex allowance will be 2.08%. The update of the allowed opex remuneration will be based on the following formula: Allowed Opex yr t = Allowed Opex yr t+1 x (1+ CPI - X) x (1+ Volume growth 2007 ) But the important news with the X factor was the confirmation that it will no longer apply to the allowed depreciation revenues, but only to the allowed opex revenues. Therefore the overall definition of the allowed depreciation revenues is now more coherent in our view with the way such remuneration component should be defined: The initial depreciation allowance to be paid in 2008 is based on the allowance for depreciation in 2004, rolled over with the price cap formula for the period and increased by the depreciation associated with the new investments included in the initial RAB of the 3rd regulatory period (ie the investments made between 2002 and 2006). The initial depreciation allowance is then updated on a yearly basis based on the evolution of the RAB (ie incremental investments + acquisitions fully depreciated assets). Therefore the depreciation component immediately reflects the contribution of incremental investments and has neither sensitivity to volumes nor exposure to an X factor. Summary The following chart shows our projections for the evolution of revenues in the 3rd regulatory period. Figure 21: Terna - estimated evolution of regulated revenues in Italy m 1,400 1,200 1, E 2009E 2010E 2011E Allow ed return Allow ed opex Allow ed depreciation Source: JPMorgan estimates. 30

31 Terna management has guided towards total regulated revenues of 1.085bn in 2008, but this is based on 2007 volumes. Allowing for some modest volume growth we would expect total regulated revenues to be around 1.093bn in For the subsequent regulatory periods we assume that the regulator maintains the same rules with a blended X factor for opex of 2%. Brazilian revenues Calculation of the revenues of the Brazilian transmission businesses is very simple. Each of the 30-year concessions held by Terna Par is the result of an auction where the winning company is the one that has offered the lowest initial fee. This initial fee is then updated yearly on the basis of the Brazilian inflation. After the first 15 years of the concession the revenue is cut by 50% and thereafter it grows again in line with the prevailing inflation rate. However, Terna has been forced in 2007 to adapt its Income Statements to IAS 8, which calls for the revenues of a concession to be accrued proportionally to the life of the concession, rather than be reported on a cash basis. This means that during the first 15 years of the Brazilian concessions accrued revenues will be understating underlying cash generation and vice versa. Once the latter factor has been taken into consideration, the evolution of the revenues of Terna Par should simply reflect the gradual integration of the different acquisitions that it has made in the last few months. Capex profile We are anticipating an upgrade in Terna s capex targets for the next 5 years in the presentation to be held on 31 January. We expect the 5-year headline capex target (ex acquisitions) to increase from 2.7bn to 3.03bn. Approximately 1/3 of the upgrade simply comes from the roll forward of the plan by one year. The rest should be attributable in our view to: Incremental investments associated with the assets acquired in the last two years. Additional investments in the elimination of the bottlenecks in the network given the additional incentive (from 2% to 3%) awarded by the regulator to such investments. An upgrade in the investments associated with the connection of wind farms to the network. Figure 22: Estimated evolution of Terna's 5-year capex plans January 2006 January 2007 January 2008E Capex plan Capex plan Capex plan > 2bn 2.7bn 3.0bn Source: JPMorgan estimates, Company data. 31

32 While the magnitude of the expected upgrade in capex byterna is similar to that of Snam (c. 10%), the acceleration in momentum should be less significant in Terna, as we already expect a meaningful rise in capex in It should be noted that the investments made in year X start to be remunerated from 1 January of year X+2. Figure 23: Terna - Estimated medium term capex m E 2008E 2009E 2010E 2011E 2012E Source: JPMorgan estimates, Company data. Unincentiv ised capex 2% incentiv e 3% incentiv e Brazil As indicated by the chart we expect incentivised investments to be on average slightly more than 80% of total investments in Italy. Financial estimates In the absence of additional international acquisitions we expect the Italian revenues to contribute a rather stable proportion of the group revenues (85% of reported revenues, 82% of cash revenues). Although a great cost-cutting effort has already been made in 2006 and 2007, we would expect Terna to keep delivering a substantial reduction in the operating expenses of the Italian regulated activities. 32

33 Figure 24: Estimated evolution of Terna's opex in regulated activities E 2008E 2009E 2010E 2011E 2012E Italian opex (real) Italian opex /MWh (real) Source: JPMorgan estimates, Company data. The reduction is mainly the result of: Progress in the integration of the pieces of the network acquired from Edison, AEM and Iride, with a continuation of the elimination of the overheads acquired. Much more importantly, the significant benefits from scale from making substantial investments to upgrade/develop an existing network. The extra operating costs of additional substations or upgrades to the existing lines in order to eliminate the regional bottlenecks should be well below the average operating cost of the group. In Brazil we estimate an increase in EBITDA margins from 75.1% in 2007E to 76.2% in 2010E (based on IAS reports). This should be the result of the gradual rise of the margins of Gtesa/Patesa and ETAU to the group levels. Admittedly there could be upside on that estimate, as a larger group should benefit from a bigger dilution of fixed costs and therefore slightly higher operating margins. However, the additional potential enhancement should be modest and we are not factoring into our estimates either any one-off costs to achieve the margin enhancement. Based on the estimated results in Brazil under IAS we estimate a 5.7% CAGR in the group s EBITDA in the 5-year period (4.9% CAGR based on reported figures). If we strip out the 48m one-off revenue booked in the Italian operations in 2006, the estimated group EBITDA CAGR in the 5-year period would be 6.9%. Excluding the 48m one-off from 2006 revenues the estimated EBITDA CAGR in the Italian business in the 5-year period would be 6.9%. The Brazilian activities are expected to report 8% underlying EBITDA CAGR (again under likefor-like reporting standards), largely driven by the gradual contribution of the recently acquired assets (underlying growth should be marginally above inflation). We are expecting the cost of debt in Italy for Terna to stabilize at 4.5% from 2008 onwards (versus 3.6% in 2006) and at 9.9% in Brazil (down from 11.6% in 2006). At the end of Q all the BR$-denominated debt was at floating rates, while in Italy 33

34 36% of the debt was at floating rates, making the proportion of floating rate at the group level reach 47%. Similar to Snam Rete Gas, the effective tax rate for the Italian operations of Terna is expected to fall to c. 35% from 2008 onwards, bringing the group effective tax rate down to 34%. We estimate a one-off positive tax revenue (non cash) in 2007 of 62m to reflect the lower value of the deferred tax liabilities in the balance sheet. Table 9: Terna Profit & Loss Account m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Group revenues 1,308 1,309 1,373 1,438 1,504 1,577 1,623 - Italy 1,120 1,144 1,163 1,217 1,278 1,347 1,389 - Brazil Group EBITDA ,026 1,086 1,154 1,194 YoY % Change 26.8% 0.8% 5.6% 6.1% 5.9% 6.2% 3.5% - Italy ,015 - Brazil Depreciation EBIT Net financials Pre-tax, pre-extraordinaries profit Tax Tax rate (%) 40.1% 29.0% 34.0% 34.0% 34.0% 33.9% 33.9% Minorities Reported Net Income Reported EPS YoY % Change 24.9% 0.9% -9.1% 5.3% 6.8% 7.5% 3.0% Recurrent Net Income Reported EPS YoY % Change 17.8% -10.6% 8.8% 5.3% 6.8% 7.5% 3.0% Gross DPS CFPS Source: JPMorgan estimates, Company data. Cash flow and balance sheet Terna is already strongly cash generative and has been generating positive FCF before dividends and acquisitions for quite some time. However, post dividend payments (and obviously excluding future acquisitions) we expect the company to be FCF positive only in Table 10: Terna Cash Flow Statement m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Net income for the period Depreciation and write-downs Minorities Deferred taxes and interests Other non-monetary items Cash flow from operations Working capital variation Capex Dividends Acquisitions / Disposals Other Net cash in (out) flow Source: JPMorgan estimates, Company data. 34

35 Table 11: Terna Balance Sheet and Key Ratios m, Dec y/e 2006A 2007E 2008E 2009E 2010E 2011E 2012E Net fixed assets 5,483 5,840 6,321 6,596 6,868 7,138 7,420 Net working capital Net tax liabilities Severance liabilities Capital employed 4,442 4,925 5,416 5,702 5,983 6,264 6,556 Shareholders funds 2,009 2,153 2,194 2,240 2,298 2,372 2,445 Minorities Net debt 2,283 2,659 3,091 3,308 3,509 3,690 3,882 Net Debt/Equity 114% 123% 141% 148% 153% 156% 159% Net Debt/Capital Employed 51% 54% 57% 58% 59% 59% 59% Net Debt/EBITDA EBITDA interest cover Interest cover ROE 19.0% 18.0% 15.7% 16.2% 16.9% 17.7% 17.7% ROCE (pre-tax) 16.2% 14.4% 13.8% 13.6% 13.8% 14.0% 13.8% BV/share Source: JPMorgan estimates, Company data. Outlook for the dividend We expect Terna management to maintain the 6% growth delivered in the interim dividend at the final 2007 DPS stage, comfortably beating again its commitment to a minimum dividend growth of 3% per annum until In the strategic presentation of 31 January we also expect management to reiterate the commitment to a minimum 3% DPS growth until the end of this regulatory period (2011). Our projections contemplate 4% DPS growth CAGR in the dividend in the period E, therefore slightly outperforming the expected management target. This should mean a pay-out ratio of 85% in 2012E. Valuation Our valuation of Terna uses the RAB of the Italian regulated business and then adds/subtracts the NPV of the different estimated operating, financial and fiscal out/underperformances. The valuation of the Brazilian business is based on the market cap of Terna Participaçoes (at BR$29/share). We reach a 12-month price target of Table 12: Terna - Valuation summary Activity Estimated value ( m) Basis Reference RAB end 2008 WACC out/(under)performance -113 NPV if divergent 3 regulatory periods Incentivised return 542 NPV from capex in 3 regulatory periods Operational outperformance 424 NPV NPV deferred tax -91 NPV of tax payments in years Transmission business 7, % premium to RAB Non-regulated domestic activities 252 7x 2008 EBITDA Brazil 1,577 EV based on market value Enterprise value 9,654 Net debt - Italy -2,629 Debt required for end 2008 Net debt - Brazil end 2008 Other financial liabilities -196 Severance and part of contingent liabilities Minority -331 Brazil Equity value 5,895 Shares 2,000 Price target ( ) end 2008 Source: JPMorgan estimates. 35

36 The RAB and the net debt As we do with Snam, we use an adjusted value of RAB and net debt in our valuation. We adjust the value of the RAB to factor in the 1 year delay between the completion of the investments and the first year when they start to get their remuneration (ie the 2008 capex included in the 2008 RAB only starts to be remunerated from 1 January 2010). This impact is included in our calculation of the WACC out/underperformance. The value of the net debt is adjusted to reflect the 90-day usual payment period to pay to the suppliers of equipment (which means that the real capital invested to build the 2008 RAB will be spent by end Q1 2009). WACC outperformance The acquisitions in Brazil and the incremental capex in the Italian grid should allow Terna to gradually increase its gearing, with the group net debt to EBITDA ratio projected to increase from 2.5x in 2006 to 3.2x in 2011 (the end of the current regulatory period). If we look just at the Italian business the net debt to EBITDA ratio should increase from 2.7x to 3.3x. This should allow Terna to gradually improve its cost of capital and to beat the regulatory assumptions in its Italian business, in our view. We estimate a WACC post-tax nominal of 5.6% for Terna, or 6.45% real re-tax (see table below). Given that in the recent regulatory review Terna has been allowed to keep the premium returns on incentivised investments for 12 years, in our base case scenario we are also assuming that the regulator will allow Terna to beat its allowed return also for 12 years. The only reason why the valuation table shows a negative value for WACC outperformance is the negative impact associated to the 1-year delay in getting remuneration to the investments made in the core Italian business. Excluding this negative effect (beyond Terna s control) we estimate the NPV of the WACC outperformance at 271m. Table 13: Terna - Estimated WACC Risk free rate (nominal) 4.30% Market risk premium 4.0% Beta levered 0.75 Cost of equity 7.3% Cost of debt (pre-tax) 4.25% Tax shield 27.50% Cost of debt (post-tax) 3.23% Gearing = D/(D+E) 42.6% WACC nominal post-tax 5.6% Corporate tax rate 35.1% Inflation 2.00% WACC (real, pre-tax) 6.45% Source: JPMorgan estimates. 36

37 However, in our view Terna could operate with an even more efficient balance sheet. We believe that the company could perfectly afford to end up this regulatory period with a net debt to EBITDA ratio of 4x at the group level. This would imply a 4.2x net debt to EBITDA ratio in the domestic business, which would be still some 10% below the same ratio for Snam Rete Gas (a difference which we believe would be adequate given the international exposure of Terna). Should Terna raise its net debt levels by re-gearing its domestic regulated business (which would imply a 900m increase in domestic net debt) our fair value would increase by 0.08 per share. However, we believe that Terna is keener to gear up its balance sheet by making international acquisitions / investments, which is a higher risk area and where value creation would be strictly dependent on the conditions of the specific deal. Therefore we believe that at this stage it is not appropriate to include any extra value from extra re-gearing in our model. Incentivised returns We are assuming that Terna is allowed the same level of incentivised returns (2% and 3% to be kept for 12 years) during 3 regulatory periods (ie 12 years) and that the split between incentivised/unincentivised investments is broadly maintained. Operational outperformance We include here the NPV of the extra cost cutting achieved by Terna versus the regulatory assumptions, assuming that the company can keep only 50% of the outperformance in the following regulatory period. As we indicated above, we believe that Terna still has the opportunity to substantially reduce its opex in Italy. We also include the extra revenues derived from the gap between the depreciation allowance granted by the regulator and the actual depreciation charge. The regulator has calculated the depreciation allowance rolling forward the base level of depreciation allowance of 2004, (the one that was based on the initial RAB in the second regulatory period), which was above the actual depreciation rate associated with that initial RAB. Risks to our rating and price target and valuation sensitivities Again the main risk to our rating and price target is that the regulator makes adverse regulatory decisions. However, the Italian regulator has just completed its regulatory review and this, in our view, not only provides visibility for the next 4 years, but also is evidence of the regulator s willingness to maintain a stable model based on allowed returns with incentives (this is the 3rd regulatory period and the model has been maintained). Other uncontrollable risk would derive from delays in the building of new electricity infrastructure in Italy associated with delays in getting the permits from the regional and local authorities. While the risk does not affect all the projected capex (future additional interconnectiosn and links with the islands are sizeable projects and they have below-average exposure to local permits), it can imply delays particularly in the highly-incentivised capex invested to eliminate the regional bottlenecks. An additional risk would come from the possibility of Terna engaging in international acquisitions in higher-risk regions. The core areas for international expansion for Terna are Brazil and the neighboring regions to Italy, which is sensible in our view, as they are areas of limited risk and where Terna has a relatively high 37

38 Table 14: Terna - Key valuation sensitivities understanding of the regulation / market rules. However, we would be more wary of expansion into countries like the Philippines (as attempted in 2006) or African countries (as reported by the press in the past). Obviously the judgement would depend on the specific acquisition, price paid and financial structure (we understand that the acquisition in the Philippines would have involved very little equity and debt guaranteed by Terna). Variable Our assumption Flex Valuation effect /share WACC outperformance Allowed during 3 regulatory periods Not possible post 2011 review Incentivised returns Allowed during 3 regulatory periods Incentives to all future capex 0.14 Gearing 3.2x Net debt to EBITDA in 2011E 900m re-gearing year capex projection 4.7bn in E 10% higher 0.03 Source: JPMorgan estimates. Will CDP sell its stake in Terna? Before 1 July 2009 the partly state-owned financial institution Cassa de Depositi e Prestiti (CDP) has to take a decision regarding its 30% stake in Terna (controlling shareholder). CDP has been forced by the regulator to decide whether to retain its stake in Terna or its 10% stake in Enel. We would expect CDP to either retain its 30% stake in Terna or sell it to other permanent shareholder (a holding company of different financial institutions), so that control is preserved in Italian hands and the shares do not come to the market. 38

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41 Other Companies Recommended in This Report (prices below as of market close on 21 January 2008) Enagas (ENAG.MC/ 18.19/Overweight), Red Electrica (REE.MC/ 38.98/Overweight) Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst s compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report. Important Disclosures Market Maker/ Liquidity Provider: JPMSL and/or an affiliate is a market maker and/or liquidity provider in Enagas, Red Electrica, Snam Rete Gas, Terna. Client of the Firm: Enagas is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-securities-related services. Red Electrica is or was in the past 12 months a client of JPMSI. Snam Rete Gas is or was in the past 12 months a client of JPMSI. Terna is or was in the past 12 months a client of JPMSI; during the past 12 months, JPMSI provided to the company non-investment banking securities-related service and non-securities-related services. Investment Banking (next 3 months): JPMSI or its affiliates expect to receive, or intend to seek, compensation for investment banking services in the next three months from Red Electrica. Non-Investment Banking Compensation: JPMSI has received compensation in the past 12 months for products or services other than investment banking from Terna. An affiliate of JPMSI has received compensation in the past 12 months for products or services other than investment banking from Enagas. Enagas (ENAG.MC) Price Chart Price( ) N 19 OW 21 N 19.1 OW 21.5N 21 OW N 18.8 N 21.5 N 18.5 OW 24.5 Date Rating Share Price ( ) Price Target ( ) 29-Mar-05 OW May-06 N Jul-06 N Dec-06 N Dec-06 OW Dec-06 N Jan-07 N Mar-07 N Mar-07 OW Dec-07 OW Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Break in coverage Jun 28, May 04, This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it over the entire period. JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight. 41

42 Red Electrica (REE.MC) Price Chart Price( ) N 30 N 34.5OW 43 OW OW 33.4 OW 38.5 OW 40 OW 51 Date Rating Share Price ( ) Price Target ( ) 29-Mar-05 OW May-06 OW Dec-06 OW Dec-06 N Jan-07 N Feb-07 OW Feb-07 OW Dec-07 OW Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Break in coverage Jun 28, May 04, This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it over the entire period. JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight. Snam Rete Gas (SRG.MI) Price Chart Price( ) Jan 05 UW N 4.9 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Date Rating Share Price ( ) 01-Feb-05 UW Jan-08 N Price Target ( ) Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Break in coverage Jun 15, Jan 22, This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it over the entire period. JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight. 42

43 Terna (TRN.MI) Price Chart Date Rating Share Price ( ) 22-Jan-08 N Price Target ( ) N 2.95 Price( ) Jan 05 Apr 05 Jul 05 Oct 05 Jan 06 Apr 06 Jul 06 Oct 06 Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Source: Reuters and JPMorgan; price data adjusted for stock splits and dividends. Initiated coverage Jan 22, This chart shows JPMorgan's continuing coverage of this stock; the current analyst may or may not have covered it over the entire period. JPMorgan ratings: OW = Overweight, N = Neutral, UW = Underweight. Explanation of Equity Research Ratings and Analyst(s) Coverage Universe: JPMorgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analyst s (or the analyst s team s) coverage universe.] The analyst or analyst s team s coverage universe is the sector and/or country shown on the cover of each publication. See below for the specific stocks in the certifying analyst(s) coverage universe. Coverage Universe: Javier Garrido: EDP (EDP.LS), Enagas (ENAG.MC), Endesa (ELE.MC), Enel (ENEI.MI), Gas Natural (GAS.MC), Red Electrica (REE.MC), Unión Fenosa (UNF.MC) JPMorgan Equity Research Ratings Distribution, as of December 31, 2007 Overweight (buy) Neutral (hold) Underweight (sell) JPM Global Equity Research Coverage 45% 41% 14% IB clients* 50% 51% 38% JPMSI Equity Research Coverage 41% 47% 12% IB clients* 71% 64% 49% *Percentage of investment banking clients in each rating category. For purposes only of NASD/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. Valuation and Risks: Please see the most recent company-specific research report for an analysis of valuation methodology and risks on any securities recommended herein. Research is available at or you can contact the analyst named on the front of this note or your JPMorgan representative. Analysts Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues, which include revenues from, among other business units, Institutional Equities and Investment Banking. 43

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46 All Data As Of 18-Jan-08 Q-Snapshot: Snam Rete Gas S.p.A. Targets & Recommendations EPS Revisions EPS Momentum (%) Historical Total Return (%) Consensus Changes (4wks) Consensus Growth Outlook (%) Targets Recoms Up Dn Total* Consensus Changes (4wks) Up Up Dn Dn Total* FY1 FY2 Quant Return Drivers (A Score >50% indicates company ranks 'above average') Score 0% (worst) to 100% (best) vs Country Peers vs (regional) IBES Industry Peers Valuations: P/E Vs Market (12mth fwd EPS) 16% 19% Valuations: P/E Vs Sector (12mth fwd EPS) 13% 14% Valuations: EPS Growth (forecast) 45% 22% Momentum: 12 Month Price Momentum 93% 81% Momentum: 1 Month Price Reversion 2% 6% Quality: Return On Equity (forecast) 43% 20% Quality: Earnings Risk (Variation in Consensus) 74% 61% Earnings&Sentiment: Earnings Momentum 70% 44% Earnings&Sentiment: Change in Recomms 39% 39% Earnings&Sentiment: Net Revisions Fy2 EPS 91% 86% COMPOSITE Q-SCORE** (0% To 100%) 69% 38% FY1 5.2 FY2 6 4 JPMorgan Composite Q-Score I N D U S T R Y Regional MSCI Industry Peers (Closest by Size, Consensus. ADV = Average daily value traded in US$m over the last 3 mths) Code Name Country USD MCAP ADV PE FY1 Q-Score** SRG-IT Snam Rete Gas S.p.A. Italy 12, % ENG-ES Enagas S.A. Spain 6, % GAS-NO BW Gas ASA Norway 1, % (%) Mth -3 Mth FY1 C O U N T R Y FY2 100% 75% 50% 25% 0% 6.7 (Local Currency %) Mth 3Mth 1Yr 3Yr EPS Actual To FY1 EPS FY1 To FY2 EPS FY2 To FY3 Cash Flow FY1 To FY2 Dividends FY1 To FY2 Sales FY1ToFY2 5.6 HIGH/STRONGER LOW/WEAKER 0% 25% 50% 75% 100% Country Peers (Closest by Size, Consensus. ADV = average daily value traded in US$m over the last 3 mths) Code Name Industry USD MCAP ADV PE FY1 Q-Score** MB-IT Mediobanca Banca di Credito Finanziario Investment Banks/Brokers 15, % BMPS-IT Banca Monte dei Paschi di Siena S.p.A. Major Banks 14, % EDN-IT Edison S.p.A Ordinary Stock Electric Utilities 13, % BP-IT Banco Popolare Regional Banks 12, % FNC-IT Finmeccanica S.p.A. Aerospace & Defense 12, % SRG-IT Snam Rete Gas S.p.A. Oil & Gas Pipelines 12, % LUX-IT Luxottica Group S.p.A. Consumer Sundries 11, % STM-IT STMicroelectronics N.V. Semiconductors 11, % AL-IT Alleanza Assicurazioni S.p.A. Life/Health Insurance 10, % MS-IT Mediaset S.p.A. Broadcasting 10, % IFL-IT IFIL Investments S.p.A. Financial Conglomerates 8, % Source: Factset, Thomson, MSCI and JPMorgan Quantitative Research. For an explanation of the Q-Snapshot, please visit Q-Snapshots are a product of JPMorgan s Global Quantitative Analysis team and provide quantitative metrics summarized in an overall company 'Q-Score.' Q-Snapshots are based on consensus data and should not be considered as having a direct relationship with the JPMorgan analysts recommendation. * Total number of target prices, recommendations or EPS forecasts that make up consensus. ** The Composite Q-Score is calculated by weighting and combining the 10 Quant return drivers shown. The higher the Q-Score the higher the one month expected return. On a 14 Year back-test the stocks with the highest Q-Scores have been shown (on average) to significantly outperform those stocks with the lowest Q-Scores in this universe. 46

47 All Data As Of 18-Jan-08 Q-Snapshot: TERNA S.p.A. Targets & Recommendations EPS Revisions EPS Momentum (%) Historical Total Return (%) Consensus Changes (4wks) Consensus Growth Outlook (%) Targets Recoms Up Dn Total* Consensus Changes (4wks) Up Up Dn Dn Total* FY1 FY2 Quant Return Drivers (A Score >50% indicates company ranks 'above average') Score 0% (worst) to 100% (best) vs Country Peers vs (regional) IBES Industry Peers Valuations: P/E Vs Market (12mth fwd EPS) 11% 41% Valuations: P/E Vs Sector (12mth fwd EPS) 23% 44% Valuations: EPS Growth (forecast) 9% 12% Momentum: 12 Month Price Momentum 94% 59% Momentum: 1 Month Price Reversion 3% 12% Quality: Return On Equity (forecast) 65% 59% Quality: Earnings Risk (Variation in Consensus) 68% 74% Earnings&Sentiment: Earnings Momentum 80% 59% Earnings&Sentiment: Change in Recomms 77% 81% Earnings&Sentiment: Net Revisions Fy2 EPS 91% 88% COMPOSITE Q-SCORE** (0% To 100%) 77% 63% FY1 1.3 FY2 JPMorgan Composite Q-Score I N D U S T R Y Regional MSCI Industry Peers (Closest by Size, Consensus. ADV = Average daily value traded in US$m over the last 3 mths) Code Name Country USD MCAP ADV PE FY1 Q-Score** UU-GB United Utilities PLC United Kingdom 12, % ATN-CH Aare-Tessin AG fur Elektrizitat Switzerland 12, % IPR-GB International Power PLC United Kingdom 12, % PPC-GR Public Power Corp. S.A. Greece 10, % BGY-GB British Energy Group PLC United Kingdom 10, % TRN-IT TERNA S.p.A. Italy 8, % REE-ES Red Electrica de Espana S.A. Spain 8, % BKWN-CH BKW FMB Energie AG Switzerland 7, % EVN-AT EVN AG Austria 5, % HNA-NO Hafslund AS A Norway 4, % HER-IT Hera S.p.A. Italy 4, % Country Peers (Closest by Size, Consensus. ADV = average daily value traded in US$m over the last 3 mths) Code Name Industry USD MCAP ADV PE FY1 Q-Score** LUX-IT Luxottica Group S.p.A. Consumer Sundries 11, % STM-IT STMicroelectronics N.V. Semiconductors 11, % AL-IT Alleanza Assicurazioni S.p.A. Life/Health Insurance 10, % MS-IT Mediaset S.p.A. Broadcasting 10, % IFL-IT IFIL Investments S.p.A. Financial Conglomerates 8, % TRN-IT TERNA S.p.A. Electric Utilities 8, % CFI-IT Banca CR Firenze S.p.A. Regional Banks 8, % A2A-IT A2A S.p.A. Electric Utilities 7, % CRG-IT Banca Carige S.p.A. Regional Banks 6, % FSA-IT Fondiaria-SAI S.p.A. Multi-Line Insurance 6, % PLT-IT Parmalat S.p.A. Food: Meat/Fish/Dairy 5, % Source: Factset, Thomson, MSCI and JPMorgan Quantitative Research. For an explanation of the Q-Snapshot, please visit Q-Snapshots are a product of JPMorgan s Global Quantitative Analysis team and provide quantitative metrics summarized in an overall company 'Q-Score.' Q-Snapshots are based on consensus data and should not be considered as having a direct relationship with the JPMorgan analysts recommendation. * Total number of target prices, recommendations or EPS forecasts that make up consensus. ** The Composite Q-Score is calculated by weighting and combining the 10 Quant return drivers shown. The higher the Q-Score the higher the one month expected return. On a 14 Year back-test the stocks with the highest Q-Scores have been shown (on average) to significantly outperform those stocks with the lowest Q-Scores in this universe. (%) Mth -3 Mth FY1 C O U N T R Y FY2 100% 75% 50% 25% 0% (Local Currency %) Mth 3Mth 1Yr 3Yr EPS Actual To FY1 EPS FY1 To FY2 EPS FY2 To FY3 Cash Flow FY1 To FY2 Dividends FY1 To FY2 Sales FY1ToFY HIGH/STRONGER LOW/WEAKER 0% 25% 50% 75% 100% 47