REN Utilities BPI EQUITY RESEARCH. Buy. Portugal. Hot 'N' Spicy. Medium Risk. 4th September REN vs. PSI20 vs. MSCI Small Cap Index

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1 BPI EQUITY RESEARCH REN Utilities Hot 'N' Spicy (YE15 Price Target Set at 3.25 (+4% LfL); Buy recommendation) 4 Focus on electricity regulatory talks following State placement: Following the State's placement of the last 11% stake, the next trigger should be the electricity regulatory review (new 3-yr. regulatory period in 2015). Some changes are expected to take place, possibly encompassing a cut to the RoA range or the elimination of the RoA premium for new assets which would likely be compensated by a higher average RoA. The Draft will be published on the 13 th Oct, with final details in mid-december. The 24mn "one-off" tax implemented by the government should not be eliminated in Valuation upgraded on sovereign link: Following model fine-tuning and a lower assumed RoA in line with yields evolution our EPS F dropped 4% LfL (15 F down 23% due to 1yr one-off tax extension). We plugged BPI's current Rf assumption for Portugal (4.4% vs. 5.6% before), positively impacting REN's valuation and trimming revenues; we are setting a YE15 Price Target of 3.25/sh (+14%; +4% LfL excluding roll-forward into YE15 and CRP assumption change). We continue to see attractive valuation optionality contingent to improved liquidity and value accretion from international investment ( 0.2/sh.). A harsher regulatory outcome calls for a bearcase scenario not too far below current mkt. price ( 2.10/sh.). 4 Trading at discount and riding a dropping cost of capital: Despite a strong YTD rally (+21%), the stock should continue to be supported by improved funding availability, while higher free-float and volume traded, along with a 6.3% DY15 F, should attract new investors. Besides, attractive multiples (12.8x P/E15 F vs. European peers at 14.7x) already seem to consider a higher risk premium reflecting capex/growth risk, macro environment, regulation uncertainty and potential overhang. BUY. Stock data Price (29 th Aug.): 2.72 Price Target (YE14): 3.25 # shares (mn): 534 M. Cap ( mn) / F. Float: / 30% Reuters/Bloomberg: RENE.LS/RENE PL Avg. Daily Vol. [ '000]: Major Shareholders: State Grid (25%), Oman Oil (15%), Gestfin (5.9%), Oliren (5%), EDP (5%), REE (5%), EGF-GCF (4.4%), Fidelidade (4%) Estimates F 2015 F 2016 F 2017 F PE Adj Dividend yield 6.2% 6.2% 6.3% 6.3% 6.3% 6.4% 7.3% FCFE Yield -8.4% -7.6% 13.9% -5.3% -3.0% -2.8% 12.6% FCFF Yield 1.4% -2.0% 8.8% 1.0% 1.9% 2.1% 8.7% PBV EV/EBITDA (1) EV/Sales (1) (1) EV is fixed with current market cap and MV of remaining items. Buy Medium Risk 4th September 2014 Portugal REN vs. PSI20 vs. MSCI Small Cap Index Source: Bloomberg. Valuation sensitivity to WACC (% chg. in Fair Value) Gas WACC 6.0% 6.2% 6.4% 6.0% 7% 5% 3% Electricity 6.2% 2% 0% -2% WACC 6.4% -3% -4% -6% Source: BPI Equity Research. Valuation/EPS sensitivity to Portuguese yields Portugal Impact Impact in Rf (%) in PT EPS 16 F -1.0% +7% -2% 4.4% 0% 0% +1.0% -6% +2% Source: BPI Equity Research. Historical Recommendation Date Recommendation 19-Sep-11 Hold 11-Jun-13 Buy 07-May-14 Restricted Source: BPI Equity Research. Analysts Gonzalo Sánchez-Bordona gonzalo.sanchez.bordona@bpi.pt Phone Bruno Silva, CFA bruno.miguel.silva@bpi.pt Phone Flora Trindade, CFA flora.mericia.trindade@bpi.pt Phone Available on our website: BPI Online, and Bloomberg at NH BPD

2 INDEX 5 Investment case 10 History & Evolution 12 Business Overview 13 Shareholder Structure 15 REN Strategic Guidelines 16 REN in the Electricity Business 24 REN in the Gas Business 30 Other REN Business Units 31 Financial Performance and Estimates 35 Valuation Considerations 35 Discounted Cash Flows 38 Dividend Discount Model 39 Multiples Approach 42 Valuation and Recommendation 2

3 BPI vs. Consensus Stock Momentum Company: REN Sector: DJ EuroStox Utilities Price Performance Forward P/E and EV/EBITDA Valuation monitor "#$% Relative Valuation EV/EBITDA BPI Consensus Sector P/E BPI Consensus Sector PBV BPI Consensus Sector Dividend yield BPI 6.3% 6.3% 6.4% Consensus 6.3% 6.3% 6.4% Sector 4.5% 4.7% 4.9% Market Price Rating ( ) $- "+.// $- Market Recommendations "# &%'( ) P&L and B\S monitor BPI estimates/consensus Revenues -2.1% 3.5% 9.0% EBITDA 0.5% 3.6% 9.7% EBIT 0.7% 2.0% 8.7% Net Profit -3.3% -3.1% 18.1% Net Debt 4.9% 10.9% 16.1% Profitability monitor EBITDA Margin BPI 63.0% 65.2% 70.2% Consensus 62.7% 62.9% 63.9% EBIT margin BPI 37.9% 38.4% 41.3% Consensus 37.7% 37.7% 38.0% Net Profit margin BPI 13.3% 14.0% 18.7% Consensus 13.8% 14.5% 15.8% Key leverage ratios Net Debt/EV BPI Consensus Net Debt/EBITDA BPI Consensus ) +, ) + Fair Value Comparison ( ) CAGR EBITDA Consensus ( mn) EPS Consensus ( ) $% $'&.// '$(./"1$ " / )#4$ $3 '( '( ) 2/ 0 0 '$(.// 5 - " 0 / Source: Factset, Bloomberg and BPI Equity Research. 3

4 REN at a Glance EBITDA breakdown by business EBITDA evolution ( mn) '" #& %$ $ % % $ $% $ % %% % % $ % % % ( $( %( #& '" ))")"# Source: REN, BPI Equity Research (F). Source: REN, BPI Equity Research (F). Investments forecast ( mn) ( ( $( %( --6' $( --6 7"' $( 7" (//"/"'$( (//"/" Source: BPI Equity Research (F). Company guidance vs BPI REN BPI F EBITDA CAGR % 4.1% Net profit CAGR 5.0% 4.7% Capex ( bn) EBITDA 2016 ( mn) Net debt 2016 ( bn) Net debt/ebitda 2016 < Financial structure ( mn) 1H14 Net debt 2453 Avg. cost of debt 4.8% % Fixed 52% % Variable 48% Source: REN. Sector Regulation Electricity Gas System Net RAB Net RAB (No update) (No update) Regulated revenues: Regulated revenues: + Fin. Remun.=Net RABNom.RoA + Fin. Rem.=Net RABNom. RoA RoA: Index to Portuguese 5Y CDS (assets pre-09), RoA: Index to Portuguese 10Y yield, ranging ranging % % Remuneration RoA: Index to Portuguese 5Y CDS (assets post-09), ranging % + Standard Opex + Standard Opex + Depreciation + Depreciation + Comercial gains + Interest tariff deviation Avg useful life 30 years 40 years Fully depleted assets a (Asset Value/# remaining years)(1+0.5roa) - Source: ERSE, REN, BPI Equity Research. 4

5 BPI has acted as co-lead manager in the recent 11% stake IPO, carried out by the Portuguese State-owned Parpublica and Caixa Geral de Depositos ("CGD"). Over this timeframe very little changes took place at the company level aside from the consequent shareholder structure changes. In this in-depth report we take a fresh view on the company's operating environment, analyse its regulatory framework in detail and provide valuation guidelines in accordance with the nature of the business, highlighting potential risks to our base case Price Target and sources of upside. REN shareholders' before Jun14 IPO INVESTMENT CASE REN is the sole electricity and gas TSO in Portugal: REN was incorporated in 1994 as a subsidiary of EDP and was in charge of the electricity transmission network in Portugal. Following EDP's sale of a 70% stake in REN to the Portuguese state in 2000, REN also became the gas TSO in Portugal after acquiring all high-pressure assets from Galp in 2006 in addition to underground storage facilities and LNG terminal. REN is today the sole owner of the concessions to operate Portugal's electricity transmission and natural gas high-pressure pipelines. The electricity grid concession lasts until 2057, encompassing 8,733Km of Very High Voltage (VHV) lines, 67 transformer substations, 13 step down, switching and transition substations and 9 interconnection points with Spain. The natural gas concessions extend into 2046 and encompass 1,375Km of high pressure pipelines, Sines LNG terminal (regasification capacity: 8bcm/year) and underground storage facilities in Carriço (3 caverns in operation 1 under construction, with a maximum capacity of 1.64TWh); 2 more caverns in Carriçio have recently been acquired from Galp for 71mn, with the deal pending closing. Source: REN. REN post-ipo shareholders' structure Two privatization stages done in 2007 and 2012: The State launched in July 2007 the 1st reprivatisation phase through an IPO, selling 19% of REN's share capital (along with a 5% stake sold by EDP) and listing the shares in the Portuguese stock market. The 2nd reprivatisation phase was carried out in February State Grid of China and Oman Oil acquired a respective 25% and 15% stake from the Portuguese State, becoming the new reference shareholders. The new owners and the maturity of the Portuguese grids drove a change in the capex strategy that is now encompassing opportunities abroad. Source: REN. The final reprivatization phase: Following the 2012 reprivatization phase, an 11% stake remained in the hands of the State holding Parpublica (9.9%) and the State-owned bank CGD (1.1%). The 3 rd and last reprivatization stage, approved by the Portuguese cabinet in April 2014 and fully executed on 13 th June through a dual retail/institutional placement, encompassed 58.74mn shares, representing that 11% stake in full. The shares were distributed among a wide base of investors, with insurance company Fidelidade becoming the only qualified shareholder (>2% stake) following the deal. Improved liquidity to drive clientele effect: The reprivatization reached the double goal of (1) disposing of the State's entire stake, complying with the State's adjustment program, and (2) increasing the stock's liquidity driven by the resulting free-float increase from c. 20% to c. 30%. REN's low trading volumes (average daily volume over the period barely reaching 0.5mn/day, 178K shares/ d, according to Bloomberg data) is in our view a relevant drawback, due to minimum liquidity levels required by some investors. The situation improved significantly in REN stock average daily volume ( mn) 0 Source: Bloomberg. + )2+289:8/; )2+$-9:%<;,% 0, 5

6 2012 following the second stage of the reprivatization (sale of a 40% stake by the State) amidst rumours of a quick placement of the State's remaining 11% stake, but liquidity receded again in Just very recently, value traded started to rise again, fuelled by a higher share price and a boost in liquidity over the last 6 months. With trading levels above 2mn/d. over the last 3 months we expect this improved situation to become permanent, eventually leading to the removal of our small caps 10% discount. Pure regulated player: REN is a regulated company that obtains close to 100% of its revenues from electricity and natural gas distribution and/or supply companies that are charged according to the tariffs set annually by an independent regulator (ERSE). REN is not exposed to electricity/gas volumes or commodity prices, as its revenues depend entirely on regulatory parameters reviewed every 3 years. The main driver of revenues is "financial return" (generally referred to by the company as "Rate of Return on RAB" or "RoR", but referred to in this report as Return on Assets or "RoA"), a variable rate (different for electricity and gas) that is set yearly by ERSE and that is linked to the Portuguese sovereign yield (or CDS in the case of electricity) evolution. On top of the RoA, REN is entitled to recover D&A (based on recognised investment or RAB) and opex charges at standard costs, with reference prices also reviewed every 3 years and subject to efficiency targets on a yearly basis. International expansion is a wild card: The potential for investing abroad could spice up things a bit according to the November 2012 strategic plan. That plan encompassed up to 0.7bn of international capex in F, potentially adding 50-60mn EBITDA/yr. from FY16, but visibility is still low. As a result, we see the possible international projects in Africa (Mozambique, Angola) and Brazil (along with State Grid) as a wild card for the medium/long term. If we assume a required equity IRR of 15% on the forecasted 700mn investment, discounted at a 12% cost of equity, we would be adding around 0.19/sh to REN's value, representing +6% on our PT YE15. Historical and expected RoA of REN's activities (%) % ($(%( ( --69<588; --69<588; 7" Source: BPI Equity Research marks the end of an extended growth phase amidst financial costs recovery: EBITDA improvement during the past five years has been the result of both RAB remuneration increase and opex reductions, while a much less impressive earnings expansion derives from a sharp increase in net financial expenses over the same period due to higher debt (on continued investments) and cost reflecting the impact of the Portuguese sovereign crisis. Financial costs were one of the key concerns in the market until very recently. The situation materially improved in 1H14, with cost of debt dropping from 5.65% in 1H13 to 4.75%. There is still scope for further improvement, backing a 2% net income CAGR F expected by Bloomberg consensus (BPI est. 6% due to contribution from international investments) despite a flattish evolution of EBITDA due to falling RoA (on Portuguese de-risking). This trend seems to be also supported by an expected improvement in ND/EBITDA ratios (ex-international investments) and by the fact that all the major rating agencies recently upgraded REN's outlook. EPS down 4% in F on lower Portuguese sovereign yields: Since our latest research note on REN we have updated our estimates in light of the Portuguese 10yr yield/5yr CDS evolution, along with a general model fine-tuning (including lower financial costs), resulting in minor changes other than the re-allocation of the "one-off" energy tax at tax expense level from operating level before (this is the REN: EBITDA & capex evolution ( mn) % $ ($(%( ( '( )."58-."5(/= Source: REN, BPI Equity Research. 6

7 driver behind our noticeable EBITDA/EBIT change in FY14 F ). As mentioned before, we have extended the "one-off" tax into 2015 F, which justifies an 18% cut in earnings. The remaining 4% EPS cut verified in F comes from our lower CRP assumption for Portugal, that results in a 4.4% Rf vs. 5.6% before. This figure, also used for WACC purposes, is the basis for our long term assumptions of regulatory parameters. 6.3% DY 15 F... sustainable shareholder remuneration: REN's management has been clear about maintaining or slightly increasing its nominal DPS yoy up to In 2014, REN has paid a DPS on FY13 earnings (75% payout) and in line with the strong message from the company we are expecting DPS to increase 0.001/sh. every year until 2016 (on FY15 earnings). This represents a peak 85% payout on 14 F earnings, with the figure going down progressively. Following the assumed end of the "one-off" tax from 16 F onwards, we expect a stabilization of payout at around 70%, supporting a sharp increase in DPS to 0.20/sh. already in 17 F (+16% yoy). Dividends paid should represent on average just c. 30% of EBITDA minus capex until 2017, reflecting the sustainability of the policy. For as long as the energy tax is in place, our assumptions point to a DY around 6.3%, with the end of it bringing a stunning 7.3% in 17 F. REN's commitment with dividend distribution is reflected in the amounts paid since its IPO in 2006, totalling 626mn or 43% of the current market cap as a reference. Improved valuation on lower sovereign yields: Following a cut in our assumption for the Portuguese Rf (4.40% vs. 5.60% before), estimates fine-tuning, a 1-year extension of the one-off energy tax into 2015 and the roll forward of our valuation horizon to YE15, we reach a new Price Target YE15 of 3.25/sh. (+14%; +4% LfL excluding the roll forward and CRP assumption change). We assume a conservative scenario for electricity regulatory developments ahead of the draft that will be published in October, anticipating a cut in the base rate cap/floor of 50bps which yields a blended 8.05% RoA 15 F, or 7.3% for assets installed until 2009 and 8.8% for assets carrying the 150bps premium. Marginally lower opex and financial costs justify the minor valuation upgrade in comparable terms (+4% assuming unchanged CRP and a YE14 valuation horizon) despite falling sovereign yields already verified in 2014 that should impact top line evolution. Changes in estimates ( mn) 2014 F 2015 F 2016 F EBITDA 7% -2% -2% EBIT 11% -5% -4% Net income -3% -23% -4% Net debt 0% -1% -2% Source: BPI Equity Research. REN dividend distribution ( /sh) Source: REN, BPI Equity Research. REN - Changes in Valuation New Old % chg. New LfL %chg. LfL Electricity % % Gas % % Other assets % 43-2% REE % 87 22% Enagas % 61 27% OMEL 1 1 0% 1 0% Total EV % % Net debt YE15 adj % % Equity % % # shares (mn) % 534 0% YE15 Fair Value ( ) % % S/C discount (10%) % % YE15 Price target ( ) % % Source: BPI Equity Research. 7

8 Optionality remains high but downside risks increase at current prices: Despite the continued stock price rally, our base case valuation offers a still appealing 24% annualised total return to YE15, supported by a hefty dividend distribution. We continue to see several sources of valuation upside, namely a trend down in cost of capital, a lower liquidity discount with the improved free-float and volumes traded and potential value creation in international investments ( 0.2/sh.). On the negative side, we cannot neglect the potential risk for adverse regulatory changes or the extension of the "one-off" energy tax. We already include in our estimates a 50bps cut in the regulatory RoA floor/cap denting 0.2/sh. or 7% of our valuation. A reversal in the sovereign de-risking or a much worse than expected regulatory review (simple elimination of the 150bps premium on new electricity assets) together with the extension of the "one-off" tax beyond 2015 would lead to a bear-case scenario of around 2.14/sh. REN valuation scenarios ( /sh) 0 0 /"" 0 012" 1$2) 34.)55"- )# ( 0 01"0 "6 /"" $2) 34,7 4&46 8)69 :7 &; 8)69 :$7 &; / ##" Source: BPI Equity Research. Valuation discount narrowing, but still material: A sharp recovery in REN share price since the beginning of 2013 has brought along a more normalised P/E 15 F of 12.8x (or 11.1x excluding energy tax one-off), but the company still trades at a noticeable 18% discount to gas/electricity European peers and c. 40% to UK water utilities, which have a similar regulatory profile. REN currently trades at a small premium to historical RAB (1H14) for the first time since 2011, and although it seems to be on an upwards pattern REN has historically shown a 17% premium (average), justified by healthy growth brought by investments carried out until Capex levels are now much lower but EPS growth prospects continue to be above average (8% EPS CAGR F ) as a result of easing cost of debt, lower leverage and international expansion. Thus, a premium to historical RAB continues to be justified in our view and we believe the gap in P/E terms should narrow further, especially if we assume (our base case) that the energy one-off tax will only be applicable in 14 and 15 F (12.8x P/E 15 F vs. European peers 14.7x). Looking forward, comparable companies currently trade at 1.1x EV/RAB 15 F on average with UK water utilities featuring a higher 1.2x multiple, while REN trades at a more modest 0.9x (15 F ). Lastly, REN's 6.3% DY 15 F is the highest among our utilities' universe, with the average in the sector around 5%. REN P/E vs. European regulated peers - - % "%--6 Source: Factset. >" 8

9 Trading at discount and riding a dropping cost of capital: Despite a strong YTD rally (+21% vs. PSI20-9% and European peers +10%), the stock should continue to be supported by improved funding availability, potential value accretion from the international expansion in ( 0.2/sh.), while higher free-float and volume traded should attract new investors. Besides, attractive multiples (12.8x P/E15 F ; 6.3% DY15 F vs. European peers at 14.7x and 5.1%) already seem to reflect a higher risk premium driven by capex/growth risk, macro environment, regulation uncertainty and potential overhang. BUY. REN trading EV premium/ discount to RAB $ < ) < ) -/)' )2"+ Source: BPI Equity Research, based on REN and Bloomberg figures. 9

10 HISTORY & EVOLUTION Incorporated in 1994 as electricity transmission grid operator: REN (Rede Electrica Nacional, S.A. at the time) was incorporated in 1994 as a subsidiary of EDP, and was in charge of the electricity transmission network in Portugal. Due to its key role in the energy sector and new EU unbundling rules, EDP was forced to sell a 70% stake in REN to the Portuguese State in That same year the Government granted REN a 50-yr. concession to operate the electric transmission network in the country. REN historical milestones Source: REN. 3-year long process to become gas TSO in 2006: In 2003, the Government proposed a restructuring of the energy sector through which GALP was expected to split its assets into three major groups: oil, to be sold in a beauty contest; gas distribution and supply, to be handed to EDP; and gas transmission assets, to be given to REN. For that purpose REN bought an 18.3% stake in GALP, that was supposed to be swapped for the aforementioned gas transmission assets, with REN becoming the gas TSO (transmission system operator). However, the said deal was aborted due to the veto of the EU Commission to the merger EDP/GDP, although the plans to unbundle gas transmission assets (high pressure pipelines, Sines LNG terminal and storage facilities) and transfer to REN were still alive. In 2006 the Portuguese Government approved a new regulatory framework which prevented a single shareholder from holding a stake above 10% (safe for the State), or 5% for energy companies. REN sold its 18.3% stake in GALP to Amorim Energia and bought the aforementioned gas transmission assets from GALP, being at the same time granted a 40-year concession to operate them. 10

11 IPO in 2007: As a consequence of the changes witnessed in 2006, REN had become in 2007 the owner of both the gas and electricity transmission assets and their system operator in Portugal. For that purpose, REN was renamed as Redes Energeticas Nacionais SGPS, S.A. (RENE PL, RENE.LS) in January 2007, ahead of the 1st reprivatisation phase through an IPO that involved 24% of REN's share capital (July 2007). Also in July 2007 a new electricity concession was agreed with the State, including new trading activity (market environment). 2 nd reprivatization phase in 2012 emerged new reference shareholders: Not much changed at REN over the period other than regulatory adjustments (the company enjoys 3-year long regulatory periods). Further down the road the most recent milestone was the 2 nd reprivatisation phase carried out in February Two new shareholders, State Grid of China and Oman Oil, acquired a respective 25% and 15% stake from the Portuguese State, becoming the controlling owners. The new owners and the maturity of the Portuguese grids drove a change in the capex strategy, which is now encompassing opportunities abroad. Last reprivatization stage meant full State exit: The recently completed 3 rd and last reprivatization stage led to the complete exit of the Portuguese State from REN's ownership, with the company becoming for the first time since its creation a Statefree venture. No material changes aruse in ownership structure, with all new shareholders pure financial investors and only Fidelidade acquiring a qualified stake (over 2%) with a 4% holding. Strategy wise nothing changed, with State Grid remaining as the leading shareholder in the decision-making process with the support of Oman Oil. 11

12 BUSINESS OVERVIEW REN is the sole electricity and gas TSO in Portugal: REN is the owner of the concession to operate Portugal'selectricity transmission and natural gas high-pressure assets. The electricity grid concession lasts until 2057, encompassing 8,733Km of Very High Voltage (VHV) lines, 67 transformer substations, 13 step down, switching and transition substations and 9 interconnection points with Spain. The natural gas concessions encompass 1,375Km of high pressure pipelines, encompass, Sines LNG terminal (regasification capacity: 8bcm/year) and underground storage facilities in Carriço (3 caverns in operation and 1 under construction, with a maximum capacity of 1.64TWh); 2 more caverns in Carriçio have recently been acquired from Galp for 71mn, with the deal pending closing. Título (1) Tariff charged through the transmission/transportation operator, mostly composed by pass-through costs, such as energy acquisition costs related with the management of the two remaining PPAs (Electricity), hydro land (Electricity), positive or negative adjustments related with costs supported by the supplier of last resort (Gas) and ERSE costs. Source: REN, ERSE. Pure regulated player: REN is a regulated company that obtains close to 100% of its revenues from electricity and natural gas distribution and/or supply companies that are charged according to the tariffs set annually by an independent regulator (ERSE). REN is not exposed to electricity/gas volumes or commodity prices, as its revenues depend entirely on regulatory parameters reviewed every 3 years. The main driver of revenues is the RoA (Return on Assets), a variable rate (different for electricity and gas) that is set yearly by ERSE and that is linked to the Portuguese sovereign yield evolution. On top of the so-called "financial return", REN is entitled to recover D&A (based on recognised investment or RAB) and opex charges at standard costs, with reference prices also reviewed every 3 years and subject to efficiency targets on a yearly basis. It is important to highlight that the regulated revenues of energy companies in Portugal are not dependent from State payments as tariffs are collected from electricity/gas customers directly in a way set by an independent regulator. Moreover, since transmission/transportation operators are at the middle of the value chain there is no exposure to consumer credit risk. 12

13 SHAREHOLDER STRUCTURE Ownership structure clarified following 3 rd reprivatization: In Feb12, the Portuguese State sold a 40% stake in REN, o.w. 25% to State Grid at 2.90/sh. and 15% to Oman Oil at 2.56/sh. Following this transaction, an 11% stake remained in the hands of the State holding Parpublica (9.9%) and the State-owned bank CGD (1.1%), a stake that was placed in the market on 13th June this year (58.74mn shares). The Portuguese utility champion EDP and the Spanish TSO, REE, hold a 5% stake each. Portuguese-controlled groups sum 20.3% of REN's shares, leaving free-float at 30%, although we see very likely that continued sales in the market lead to further changes in the short term. REN's Board of Directors is composed by 15 directors: 3 executives, 4 independent and a total of 8 Directors representing key shareholders. State Grid and Oman Oil are now the reference shareholders of the company, holding 3 and 1 seats in the Board, respectively. Other shareholders represented in the board are Gestmin (1), REE (1) and Oliren (1). State-owned holding Parpública used to have 1 board member as well, Mr. Aníbal Santos, but was considered an independent board member after the sale by the State and will be in his position until the end of his mandate at YE14. REN current shareholders' structure Source: REN. Potential overhang from other core shareholders: We believe that other shareholders could follow Portugal's lead and sell all or part of their stakes. EGF-GCF, Gestmin, Oliren and EDP have a combined 20.3% stake and, although there is no indication about these shareholders' intentions, we believe that estimated unrealized capital gains and, in the case of EDP, the urge to deleverage, could lead to a near term exit. We estimate that at current prices all four core shareholders are making attractive profits taking into account their entry prices, with EGF-GCF and Gestmin at the forefront with an entry price (adjusted for dividends) of 2.30/sh. (BPI est.) and 1.90/sh. (BPI est.), respectively - Oliren and EDP have a 2.37/sh. (BPI est.) adjusted entry price, same as REE which in our view is comfortable with its position. As far as we understand none of them is under financial stress, but the recent stock price rally represents a good opportunity to monetise at least part of the stake. This has been the case of EGF-GCF already, which has reduced its stake by almost half from 8.3% to 4.4% in only a few weeks pretty much during the State sale process. REN post-ipo shareholders' structure Shareholders' entry prices (, BPI estimate) 6 6$ 6 6$ 6 6$ 6 '0).#) '('( /65-9; /65-9"#43#2#/#;9;./9; Source: CMVM, BPI Equity Research. Shareholders' unrealised capital gains ( mn, BPI estimate) '0) #) =)"#4""#")::0); 64::0); )0):-46;::0); '('( Source: REN. 13

14 Improved liquidity to drive clientele effect: The reprivatization reached the double goal of (1) disposing of the State's entire stake, complying with the State's adjustment program, and (2) increasing the stock's liquidity driven by the resulting free-float increase from c. 20% to c. 30%. REN's low trading volumes (average daily volume over the period barely reaching 0.5mn/day, 178K shares/ d, according to Bloomberg data) is in our view a relevant drawback, due to minimum liquidity levels required by some investors. The situation improved significantly in 2012 following the second stage of the reprivatization (sale of a 40% stake by the State) amidst rumours of a quick placement of the State's remaining 11% stake, but liquidity receded again in Recently, value traded started to rise again. We expect this improved situation, with trading levels above 2mn/d. over the last 3 months, to endure, eventually leading to the removal of our 10% discount on fair value. REN stock average daily volume ( mn) 0 + 6# 0::0); 6::>6;,% 0, Source: Bloomberg. 14

15 REN STRATEGIC GUIDELINES Main strategic focus is stability of the company's returns: REN has a clear and clean strategy that pivots around four pillars: (i) stable and resilient regulated business model, enhanced by operational and technical efficiency, that ensures strong cash flow generation (8.4% FCFF yield 15 F ex-international expansion); (ii) sustainable and attractive shareholder remuneration (6.6% DY 15 F ); (iii) solid financial position (4.5x ND/EBITDA 15 F ex-international expansion and decreasing); and (iv) internationalizations along strategic investors ( 700mn investment foreseen by 2016 F ). These key priorities are to ensure profitable growth in the coming years, preserving an efficient capital structure and diversifying risk. To achieve this, REN management maintains a cooperative working relationship with the regulator (ERSE), which has been promoting a stable regulatory environment that in our view has spurred a sustainable and fair playground to stakeholders. Efficient capital structure on track: Financing of the company has been troublesome during the worst years of the sovereign crisis, with cost of debt peaking at c. 5.7% in 1Q13. The unwinding of the sovereign crisis and the refinancing carried out during FY13 have improved materially REN's position, with cost of debt at 4.75% in 1H14 and an average maturity at close to 4.3 years. Leverage was an issue only some months ago but, with funding ratios well into investment grade territory (although Portuguese sovereign rating prevents a formal upgrade of REN's own credit ratings), the company's aim is to work towards ensuring future access to funding at competitive rates and guaranteeing dividend sustainability. International expansion is a wild card: The potential for investing abroad could spice up things a bit according to the November 2012 strategic plan. That plan encompassed up to 0.7bn international capex in F, potentially adding 50-60mn EBITDA/yr. from FY16, but visibility is still low. As a result, we see the possible international projects in Africa (Mozambique, Angola) and Brazil (along with State Grid) as a wild card for the medium/long term. If we assumed a required equity IRR of 15% on the forecasted 700mn investment, discounted at a 12% cost of equity, we would be adding around 0.19/sh. to REN's value, representing +6% on our 3.05 PT YE15 for the company. Guidelines to achieve strategic priorities Source: REN. 15

16 REN IN THE ELECTRICITY BUSINESS Stable electricity system with increased weight of renewables: The Portuguese electricity generation mix has been gradually shifting towards renewables (hydro and wind). Traditional generation capacity has been roughly stable over the past 10 years (some fuel plants decommissioned replaced by CCGT capacity), while wind and the remaining renewables sources have increased significantly both in terms of installed capacity and weight in demand coverage. In fact, renewables generation accounted for 45% of the total consumption during 2013, o.w. 24% was covered by wind. Hydro output represented another 24% of the demand, meaning that c. 70% of the total electricity demand in the country was covered by CO2 free technologies. Total installed capacity reached 17.8GW at the end of Demand has shown a more erratic trend in line with the economic environment in the country, with a clear negative trend witnessed since started to show some signs of recovery, though. In 2013 total demand in Portugal amounted to 49.2TW (+0.2% yoy). Portuguese electricity system: Installed capacity (GW) Portuguese electricity system: Comsumption by source (TWh) $ $ % % $ % $ $ $ $ $ $ $ $ %?&4 "# '+ ( $ %?&4 "# '+ ( 0 Source: DGEG, BPI Equity Research. Interconnection with Spain and the rest of Europe: The Portuguese electricity system is becoming more and more integrated with the Spanish market due to the ongoing investments to increase interconnection capacity (currently 9 points) and the creation of the integrated market (MIBEL), in which REN plays a key role as the TSO. Additionally, several initiatives by the sector associations across Europe, supported by the EU, are leading to a deeper integration of the different electricity markets in order to diminish price divergences and thus increasing efficiency and protecting consumers across the region. This is being achieved through market coupling, coordinated explicit auctions and single price area. In this regard several regions have already been created or are in the process of being created, but are currently at different stages of market development and market integration. 16

17 Cross-country electricity markets in Europe (2012) Source: ERSE. The Mibel is one of the most integrated markets in Europe in terms of energy sales and pricing, with operators from both sides of the border being able to operate in both countries. However, there are clear differences in terms of tariff regimes and remuneration methodologies, mostly affecting the regulated activities, as well as a dual-company operation system. New installed capacity to further increase the technical pressure on REN: The high weight of renewables and hydro in the Portuguese generation mix together with the still tight interconnection with the Spanish system poses a technical challenge on the system operator. In the coming years, only a number of additions are expected into the generation fleet, the most notable being the last turbines installed by ENEOP (c. 200MW during 2014) and the pending 500MW of new hydro capacity to be completed by EDP. The introduction of hydro capacity with pumping improves the ability to manage the system, but overall, the dimension of the challenge for the system operator is already significant, making REN's role even more important. REN's paramount position in the Iberian electricity system: As already mentioned above, REN plays a key role in the Portuguese electricity sector as it is the sole Transmission System Operator ("TSO") of the electricity system, holding a 50-year concession that will terminate in The concession assets are owned by REN up to the concession term, when they revert to the State in exchange for their net book value. REN's facilities comprise the entire electricity grid in Portugal with a voltage in the kV range (Very High Voltage or VHV lines), comprising 8,733Km plus 67 transformer substations with a capacity amounting to 34,984MVA. REN's grid also comprises 13 step down, switching and transition substations and 9 interconnection points with Spain. REN's closest peer, REE in Spain, operates a 42,008Km network with a transformer capacity of 80,695MVA. 17

18 REN's electricity grid Source: REN. REN activities are defined in the concession agreement: REN's activities in the electricity sector are performed under a public service concession contract. Under the 50- year concession agreement signed in 2007, REN has the following functions: - Operation of the system, including management interconnections - Technical operation of market planning - Compensation for energy imbalances - Operation of CMECs - Planning, construction, operation and maintenance of the VHV electricity transmission grid and international connections The first 4 functions are exercised under the "overall technical management of the National Electricity System" activity and remunerated through the "overall system use tariff", while the last function is carried out under the "electricity transmission" activity and is remunerated through the "transmission grid tariff". Tariff methodology based on a remuneration build-up scheme: Remuneration of the regulated activities is based on the definition of the allowed revenues, which assure the principle of recovering operating costs (with efficiency targets) as well as the cost of capital. The model is defined for 3-year regulatory periods (the current one running from January 2012 to December 2014), during which the relevant 18

19 parameters remain stable. The regulatory model framework for the next period ( ) should be defined by December 2014, following the release of the general guidelines for public consultation in June/July 2014 (expected). Allowed revenues are paid by final customers: Allowed revenues are earned through the tariffs charged to final consumers through distribution companies. ERSE, the Portuguese energy regulator, sets the regulated tariffs ex-ante every year based on estimated demand and required updated inputs used in the remuneration framework. The final tariffs applicable to customers include the sum of the energy cost (non-regulated) and all the regulated tariffs for the network and system access, which are paid by distributors, which in turn charge them to final consumers. One of the regulatory guiding principles for the definition of energy tariffs is stability. Electricity Value Chain Source: REN. Ex-ante revenues set at the year's start; deviations recovered over 2 years: The aforementioned tariffs are based on a model of ex-ante allowed revenues, although deviations are compensated in the following 2 years. The allowed revenues cover: - Net operational costs subject to efficiency limits in some cases, accepted costs and pass-through costs (including fixed assets depreciation); - A regulatory RoA on the net book value of fixed assets of each activity (net of subsidies); - Tariff deficits of previous years plus interest associated with these tariffs (Euribor + a spread defined by the regulator); - Incentives and other smaller items. REN-Allowed Revenues 2014 mn Global System Operation Energy Transmission Total Source: ERSE & REN. The allowed revenues do not include: - Any inflation rollover of assets; - Any remuneration linked to working capital. The RoA is recalculated by ERSE for each regulatory period and different methodologies have been applied in the past, with the most recent one being based on a non-linear relation with 5-yr Portuguese CDS. ERSE estimates the WACC of the different activities before setting the base RoA, in order to assess the sustainability of the system. 19

20 REN's electricity activities regulatory framework Source: REN. Hydro sites remuneration: REN is also owner of the land where hydro power plants sit. Those sites had no remuneration before 2004 and were only depreciated (as their value at the end of the concession should be zero). However, in 2004 ERSE recognised that those sites should be remunerated, first at a market rate, then at inflation and then at a rate of c. 3%. However, in October 2013 the Government changed the way these assets were remunerated incorporating a transitory period in 2014 (0.056% rate over the net RAB) and from then on a defined rate depending on the level of REN's performance measured by an audit committee relative to certain duties of its role as the system operator. Financial remuneration framework changes in response to Portugal's sovereign crisis: As a result of evidence of a decoupling of Portuguese companies' cost of capital from the sovereign yields witnessed in 2011, the energy regulator ERSE carried out in that year a review process for electricity assets regulation for the period. The return on assets (RoA) for electricity assets was formerly directly linked to the previous one-year Portuguese 10-yr bond average, making returns highly volatile in the prevailing macro environment in 2011 and allegedly distorting a fair remuneration based on the perceived effective cost of capital of REN. Electricity RoA vs. Portuguese 5yr CDS (%) Current electricity regulation diminished return's ST volatility: In mid-dec.2011 the Portuguese energy regulator ERSE confirmed a change in REN's electricity remuneration framework that had already been advanced in that year's October draft proposal: % $ $ )."5 - ERSE established a new indexing system for the RoA of regulated activities, departing from a risk free rate of 3.41%, based on the moving average of the Source: ERSE, BPI Equity Research. 20

21 yields of the European countries with AAA rating (Germany, Finland, France, Austria and the Netherlands) over the previous 3 years, and a spread. The initial spread was based on the differential between the RoA initially defined for the company's regulated activity (9.0%) and the risk free rate (3.41%). - The spread is indexed to the average daily quotation of the 5Y CDS of the Portuguese Republic, with the starting point of the index being 7.80%. If the CDS increases or decreases between 0 and 3 percentual points (pps) from the departing 7.8% level, a linear step up or step down of between 0 and 0.75pps will be applied to the RoA; if the value goes up or down between 3pps and 7pps, the RoA will be increased or reduced by up to ±0.75pps, limiting the total ROA change to ±1.5pps with a cap and a floor of 10.5% and 7.5% respectively. Additionally, the remuneration of assets valued through reference costs (new installed assets since 2009) can be entitled to a 1.5pps premium on the RoA. This methodology helped controlling potential excessive volatility in returns of regulated activities when compared to the previous direct link to Portuguese secondary market sovereign yield. On the other hand, the predictability of the company's results decreases as the final RoA will only be known at the end of the year, as the reference spread for year n is based on the average CDS in the Oct (n- 1) to Sep (n) period. Capex efficiency incentive makes average return quite attractive: The so-called capex efficiency incentive mechanism allows for the addition of a 150bps premium to the base RoA for assets entering operation after 1/Jan/09, if REN is able to achieve an effective investment cost ("CREAL") no greater than 1.1 times a reference level determined by the regulator ("CREF"). The recognized RAB for assets entitled to the premium will vary between 1.05 times the effective cost and the average of the effective and reference costs. For investments overcoming 1.1 times the reference cost, the RAB assumed for remuneration purposes will equal the effective cost. In the end, this incentive is currently applied to over 90% of the assets put into operation by REN since Capex efficiency incentive Source: REN. 21

22 With the new gas regulation in place; discussions are on-going for electricity (Jan15): The gas assets' current regulatory period started in Jul13, assuming a transition from a fixed to a variable RoA indexed to the Portuguese 10-year yield. The framework sets a ROA floor and a cap (7.33%-10.50% for high-pressure pipelines) which correspond to an average Portuguese yield of 2.5% and 21.5%, respectively, with linear variations in between. The Electricity regulatory period runs until Dec14, but according to management discussions have already started for the next period (Jan15-Dec17) and the outcome will be likely similar to the one in gas. Changes expected; with limited impact in our view: We believe there should be a continuity in the current electricity allowed returns scheme, which encompasses a base RoA (linked to Portuguese CDS) for assets with no efficiency incentive and a +1.5pp premium for assets with efficiency incentive. Yet, we believe this framework may be adapted, likely encompassing two main alterations: (1) Link to Portuguese 10-yr. yield: The link to CDS was established at the peak of the sovereign crisis, in a moment when the secondary market for the bonds was illiquid and rate levels apparently disconnected from the context of the cost of capital of regulated utilities. Things are now returning to normal, increasing the relevance of the Portuguese 10-year yield as a reference to companies' cost of capital. We do not expect a change in the indexing to have a material impact in electricity assets returns, as the similarity between electricity and gas returns point out. (2) Elimination of the efficiency incentive premium for assets post-09: This could in principle raise some alerts once newsflow on regulatory discussions make way to the press. Nevertheless, we believe that, taking into account the still noticeable investments being done in the Portuguese grid (links to new hydro plants, dams, new interconnections with Spain, further renewables integration and environmental capex) and following the principle of remuneration stability, the regulator should opt for a common RoA for all assets that yields a similar or slightly lower return than the current average for the overall pool of assets. REN RoA vs. Portuguese 10yr yield (%) % <"). $+"66# ) --69<588; ) --69<588; ) 7" Source: Bloomberg. Historical and expected RoA of REN's activities (%) For now we have assumed in our base case estimates that the premium is maintained, but assume for conservative purposes that the overall return is lowered in light of the improved cost of capital prospects, reducing the RoA floor/cap by some 50bps, or 33bps vs. the gas system. % ($(%( ( --69<588; --69<588; 7" Electricity represents c. 75% of REN's EBITDA: Electricity is the main source of revenues for REN (c. 75% of EBITDA), which saw its return on RAB going from 145mn in 2011 to 180mn in 2013 as a result of continued investments. A material drop in 2013 vs (-10%) was due to the indexation of the base rate of return to CDS; which started to come down as the sovereign debt situation improved. Average RAB in 1H14 for electricity assets was 2 085mn, with a RoA of 9.3% for assets with premium and 7.8% for assets without premium. Source: BPI Equity Research. 22

23 REN: Electricity revenues evolution REN: Electricity EBITDA evolution ( mn) ( mn) $ ( $( %( (?5-26?<2//" //)' Source: REN, BPI Equity Research. $ 0 ( $( %( ( 23

24 REN IN THE GAS BUSINESS Natural gas introduced in Portugal to reduce oil dependence: Natural gas was introduced in Portugal in 1997 in order to provide a competitive, convenient and ecological energy source. Besides allowing the diversification of Portugal's energy resources, natural gas reduces oil dependence and increases the competitiveness of the Portuguese industry. Galp was the leader of this project and participated in every development stage of this sector in Portugal, both in the construction of high and low-pressure infrastructures and in the creation of the Portuguese natural gas market. EU rules forced the company to unbundle its high-pressure pipelines that were transferred to REN in Transportation and distribution are regulated businesses while supply is liberalized: The natural gas enters the Portuguese market through the high-pressure pipelines or LNG terminal managed by REN, and is then transferred to the distributors (6 concessions, 5 o.w. are Galp's and one EDP's), which in turn deliver the gas to the supplier's customers. The sale of natural gas in Portugal is organised in three large segments: the electricity segment, which includes the electrical plants of Pego, Lares, Tapada do Outeiro and TER (Termoeléctrica do Ribatejo), the industrial segment, which includes several industries such as ceramic, textiles, the food industry and the glass industry, and natural gas marketing companies that supply customers with lower consumption levels, such as residential customers and small enterprises. Sluggish demand on poor CCGT utilization: Demand followed a growth trend since the introduction of the natural gas in the Portuguese market until 2010, but started a downwards trend over the past 3 years as a result of lower CCGT load factors in response to the oversupply in the Iberian electricity market and poor demand dynamics. Nevertheless, industrial and residential segments have continued to show a strong performance even during the crisis years, with demand featuring a 9% CAGR over the period. Portuguese gas consumption by source (TWh) %6 6 6% $6% 6$ $6 $6 $ 6 $%6 6 % $ % )))"# #& Source: BPI Equity Research. REN is present in all phases of high-pressure natural gas chain: Today, all the natural gas used in Portugal comes from third countries. A part is received by high-pressure pipeline and the other by sea in the form of liquefied natural gas (LNG). REN Gasodutos operates the National Natural Gas Transport Network (RNTGN), which 24