Fortum Oyj: Russia Seizes Assets And Stock Becomes Cheap (FOJCF)

Dear readers/followers,

A couple months ago I wrote an article on a Scandinavia-based utility Fortum Oyj (OTCPK:FOJCF) explaining what the company does in detail and focusing on two issues that the company had been facing. I really encourage you check out that article to get an understanding of the whole situation. At time of writing that original article, one of the two aforementioned issues had already been resolved. In particular, Fortum had reached a deal with the German government to take over Uniper, which although it resulted in a EUR6 Billion loss, allowed Fortum to deleverage their balance sheet significantly and was largely a positive for the future of the company.

The second issue, of course, had to do with their Russian exposure where a large portion of the company’s conventional energy generation assets were located. Since Russia invaded Ukraine in early 2022, everyone knew that having assets in Russia wasn’t ideal so management slowly started writing down the value of these assets. But since they were continuing to produce solid cash flow, the market was pricing the Russian assets at roughly 4.5x earnings as of the time of my original article, which was too high in my opinion. Frankly, I didn’t have much hope that Fortum would be able to return business as usual in Russia.

Management had tried to dispose of these “toxic” assets, but they made no progress on their plan as their application for permission to sell was never approved by Russia (unsurprisingly). I came to the conclusion that while the rest of Fortum’s portfolio was very good and likely to grow, I wasn’t willing to invest into the company as long as Russian assets were valued at more than zero. The call has paid off as Fortum returned -12% vs +10 for the S&P 500 since March 15, 2022.

Note: As always the article will be based on the native EUR-denominated ticker FORTUM which trades on the Helsinki exchange in Finland. There is also an ADR available under the ticker FOJCY. Do your own research on tax implications.

News regarding Russia

The main reason why the HOLD call has paid off is that recently the Russian government has seized Fortum’s assets in Russia. The CEO of Fortum has confirmed this:

We are deprived of our shareholder rights and have assessed that we no longer have control over our Russian operations.

As a result, Fortum classified their Russian operations as discontinued and will take a EUR1.7 Billion impairment to their book value in Q2 2023, essentially writing off all of their Russian operations. Obviously, this event has hurt the company in the short term as they lost access to those cash flows I was talking about. At the same time, though, this solves the second major issue the company has been facing and will allow Fortum to focus on their long term plan to focus on the Nordics market without any historical problems weighing them down.

This news has caused the stock price to fall to EUR12.30 per share, which is exactly the level I was calling out in my original article as a level where the stock should trade excluding their Russian assets, because it represented a fair P/E of 10x on their core activities. With both risks eliminated and priced-in, now is a great time for a quick recap of their core portfolio and potentially for an upgraded rating.

Fortum’s portfolio

Note: All that follows, is based on Fortum’s continuing operations (excluding Russia). Fortum is a top 10 largest green energy producer in Europe and a dominant player in the highly fragmented Nordic market (3rd biggest energy producer and the biggest provider of electricity to retail customers).

The company has an almost entirely (98%) green portfolio with 9 GW of installed capacity, mainly located in Sweden and Finland. About half of this comprises of nuclear power, with the other half from hydro power. Last year, they generated 43.5 TWh of power and are well on their way to surpass it this year.

Future growth opportunities are fairly exciting as electrification and decarbonization are expected to double energy demand over the next three decades in Nordics alone. Internationally, Fortum’s growth prospects are also looking better than ever. This is because the Nordics have some of the cheapest and cleanest energy in Europe and there are many interconnections with mainland Europe being built to transport this energy to the continent. These interconnections should increase the overall Nordic export capacity by 30% (to 13 GW) over the next three years.

Financials

Ignoring the impact of Russia, operational performance in Q1 has been great, as higher energy prices drove EPS from EUR0.26 to EUR0.54. For the rest of the year, visibility remains high as 70% of generation is hedged at 50 EUR/MWh. For 2024, hedges are at 45% at a price of 45 EUR/MWh.

I also want to point out that Fortum’s debt is extremely low for a utility company. As of Q1 2023 they had a net debt to EBITDA below 1x. Not only that, but they have a solid BBB rated balance sheet with abundant liquidity (EUR3.4 Billion in cash) to cover all debt maturities until at least 2026.

The dividend which has previously been cut from EUR 1.14 per share to EUR 0.91 per share, currently yields 7.4% and is well covered by last twelve months earnings of EUR1.90 per share. The company has a payout policy of 60-90% of EPS so it’s likely that when things stabilize (which could be as soon as Q3 of this year), they will increase the dividend back to as least EUR 1.14 per share. Consequently the yield on cost could approach 10%.

With no Russian assets on their books anymore and the Uniper fiasco sorted out, Fortum is in the best position it has ever been to focus on the core Nordics market and capitalize on the clean cheap energy they can produce with their portfolio of green assets. The price has reached EUR12.30 which is a level I was previously comfortable investing at and on top of that the company has delivered great Q1 results in their operational segment.

With last twelve month earnings of EUR1.90 the stock trades at a P/E of just 6.5x which leaves a 50% upside to my 10x target outlined in my previous article. Since the downside has now been severely limited, I upgrade Fortum to a BUY here at EUR12.30 for the native share with a PT of 10x earnings, or EUR19 per share.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.