Enel CFO to raters: wake up to sustainability
Enel is banking on saving money on its cost of debt by using sustainable finance, as it increases its use of sustainability-linked bonds. But it sees this as a halfway house, until the rating agencies properly reflect the company’s sustainability with better credit ratings.
The world’s biggest private sector power company held a capital markets day in Milan on Tuesday, at which it unveiled a new strategy for 2020-22.
Francesco Starace, the CEO, discoursed widely on the energy transition, unrest in Latin America and why Enel is staying out of offshore wind.
But the main thrust was to announce an acceleration in Enel’s drive to reshape itself around the principle of sustainability.
It is planning €28.7bn of capex in the three year period, including €14.4bn on decarbonisation. Of that, €11.5bn will go to increase its renewable energy generating assets by 4.7GW a year — an even faster rate than the 3GW a year it has managed in the past three years, which Enel claims is a world record.
Enel will also invest heavily in upgrading power grids; promoting electrification; and Enel X, its portfolio of energy services businesses.
Net debt will rise 3% to €47bn but Enel predicts that Ebitda will grow 13%, so that its leverage multiple will stay at the present level of 2.6 before dipping to 2.3 in 2022.
Enel is lifting its dividend floor from €0.32 to €0.40 a share by 2022, and reaffirmed its policy of paying shareholders whichever is higher of the floor or 70% of ordinary net income.
Shaking up green bonds
Structures like this have become popular in the syndicated loan market in the past two years, but Enel is the first — and so far still the only issuer — to have tried it in the bond market.
Enel calls them Sustainable Development Goal-linked bonds, because it says the targets will contribute towards achieving some of the UN SDGs.
“This was a bomb in the green market,” said Alberto de Paoli, Enel’s CFO, in an interview with GlobalCapital. “It’s clear that we are accused of greenwashing for doing this new kind of SDG bond. Nobody was keen to say ‘what is this new innovation so we can have a wide portfolio?’ Some were saying this is something which we can greenwash better than with the previous instrument.”
The shorter dated bonds are tied to a pledge to raise the proportion of its power generating fleet that is renewable from 46% at issue to 55%, by December 31, 2021.
On the 15 year bond, Enel will pay the 25bp step-up if it fails to reduce its average direct greenhouse gas emissions from electricity generation from the 2017 level of 411g/kWh to 125g by December 31, 2030.
The European Union’s planned Taxonomy of Sustainable Economic Activities is set to declare 100g/kWh as the threshold for energy to be considered sustainable. Solar and wind power usually come below that level; unabated gas exceeds it.
Enel has said it will only issue this kind of bond in future, abandoning both traditional green bonds and ordinary bonds. It believes these bonds are superior because they focus the conversation with investors on Enel’s overall sustainability performance, rather than just the characteristics of a subset of assets on its balance sheet. They are part of a drive by Enel to persuade equity and debt investors to more fully recognise the value of its efforts to become sustainable.
Hopes and fears
The product’s rapid growth in the loan market shows that it could have huge potential for corporate bond issuers, particularly because such deals are easier for a company to put together than a conventional green bond, which involves identifying green assets and tracking how the money is allocated to them.
Some green bond investors welcomed the innovation, but there was also puzzlement and scepticism. Many felt the new structure was less rigorous than a traditional green bond based on use of proceeds, which gives the investor detailed information about specific assets and which some investors regard as having “impact”.
The deal has sparked a flurry of activity at the Green Bond Principles organisation, which has put all its effort in the last five years into building an architecture for the market around tracked use of proceeds. The GBP is working out how to respond.
An influential green bond banker recently told GlobalCapital that he expected the GBP to issue guidelines for the new product.
Bullish on costs
But despite these issues, Enel is so confident of the virtues of the new structure that it included a slide in its capital markets day presentation explaining that it expected to save money as a result of its use of sustainable finance.
The first two deals were both priced very tightly, having attracted strong demand from investors, including those who were following environmental, social and governance strategies.
Enel reckoned the dollar bond had come 10bp through its curve, whereas it would have had to price a normal bond 10bp above the curve. Investors were attracted by the issuer’s overt commitment to its sustainability strategy and by the prospect of a step-up coupon, should Enel fall short.
Bankers and the issuer estimated the three tranche euro deal had been priced about flat to Enel’s curve, which meant the sustainability feature had saved it from paying a new issue premium of perhaps 5bp-10bp.
Enel said in a statement on Tuesday: “The share of sustainable finance sources, such as SDG-linked bonds, on Enel’s gross debt is expected to increase to approximately 43% in 2022 and to around 77% in 2030 from approximately 22% currently, supporting a sharp reduction in cost of debt.”
Value of sustainability
Asked how Enel could be so confident that it could save money by financing itself this way, de Paoli said: “I got €4bn with an average seven years maturity and I paid 0.4% [weighted average coupon in euro terms]. That’s a big tranche of cost reduction. We are benefitting from two things. One is very low interest rates, but we are getting now a discount on spreads.”
The company stated: “Enel expects the cost of debt to be reduced to 3.8% in 2022 from 4.2% estimated in 2019, as a result of lower interest rates and the improvement of the group’s credit metrics, as well as the progressive substitution of traditional with sustainable finance instruments, with a proven positive effect on the cost of issuance.”
That 4.2% has been achieved partly through €9bn of liability management Enel has done in 2019. Enel is also centralising its funding at group level. It expects to have 67% of debt centralised by 2022. De Paoli said in the analyst presentation that despite planning to increase its debt, Enel would reduce its net interest expenses by about €300m in the next three years.
In the next three years, it expects to refinance €5.5bn of bonds at an expected cost of 1.7%, €4.1bn of bank loans at 0.9%, €1.1bn of hybrid capital at 2.6% and €3.1bn of emerging markets debt at 6.7%. The blended cost will be 2.7% on debt that now costs it 4.2%.
Over the last three years, Enel had experienced “constantly growing demand” for its sustainable debt instruments, de Paoli said, enabling it to obtain a “10% discount in the cost of issuance”. Green finance instruments “fit best to fund a fully sustainable business”, he said.
“The value of sustainability is reflected in demand,” he added, referring to the $1.5bn bond in September having been four times oversubscribed. “The cost of issuance of SDG-linked bonds is on average 15bp lower than the plain vanilla kind.”
De Paoli explained to GlobalCapital: “I’m getting this discount because I’m saying — if I hit a target in three years or 10 years on sustainability, at that year I will be more profitable and less risky. That’s why I put a step-up if I haven’t reached the target. Not because I punish myself because I didn’t get it, but because I’m offering you [the investor] a company with the missing target that will be less profitable and more risky. That’s the system we are working on.”
How much of a stretch?
Investors are wrestling with the issue of whether the triggers Enel has set for the step-up coupons are stretching enough. Some feel an urge to estimate the probability of it failing to hit the targets, so that they can put a value on the step-up coupons.
But this approach ignores the fact that, barring a disaster, Enel will hit the targets. It fully intends to, since these targets are part of its core corporate strategy, which management has declared to the stockmarket and hung its reputation on delivering.
The step-up will give investors a bonus if it fails, but buyers should not expect that to happen.
Indeed, Enel confirmed that, naturally enough, it had not designed the bonds with targets that it did not expect to hit.
Building as much new renewable energy generation capacity as Enel was doing was not easy, de Paoli said. “The effort is putting online 5GW — it surely is an effort.” No other company had done as much as 3GW a year. He added: “Everybody is saying ‘now I do 100MW, tomorrow I will do 3GW’ — good luck!”
But reaching its build targets would not involve changing the company’s direction. “It’s something that will come naturally within the strategy we are following,” de Paoli said. Hence, “If you link the business strategy to it, it’s clearly an easy task [to hit the bond targets], and for us it’s an easy task. It’s not something that will reshape the company — it’s something that the company is following. We don’t have to do any big steps to reach this target.”
For some investors this is a problem — they want to feel that the bonds will take Enel further into green territory than it was already going.
Addressing this reaction, de Paoli said: “The problem is when a company decides to work entirely with sustainability, for us it’s business as usual. We see this kind of business to be more profitable.”
Because renewable plants are quicker and easier to build than conventional ones, Enel can start earning money from a new plant in under two years, and after that it has no fuel costs. Renewable power takes priority in national grids, so that the more clean electricity there is, the more gas and coal plants are run below capacity, making them inefficient.
This enabled Enel to make more money from power in 2019, even though its generation had fallen.
Enel predicts that its value creation spread (return on invested capital/weighted average cost of capital) would rise from 370bp this year to 440bp in 2022.
Challenge to the rating agencies
From that point of view, Enel’s target of increasing renewable generation, and its conviction of success, underlined by the step-up coupon, ought to be something that is followed and valued by investors in all its debt, not just the sustainability-linked bonds.
That is what Enel thinks too. Its group treasurer Alessandro Canta told GlobalCapital in September that Enel’s whole dollar curve had tightened by 3bp-5bp since the new bond was issued, and that he thought over time, the gap between the two curves ought to narrow.
De Paoli went further. “That’s why I am shouting to the rating agencies, because the fact that I’m getting a discount on spreads because of sustainable finance when I am a fully sustainable company means a sustainable company is going to deserve a better rating,” he said.
Enel is rated Baa2/BBB+/A-, having been upgraded by Fitch this year and put on positive outlook by Moody’s.
But de Paoli believes they are not properly taking into account the fact that Enel is pursuing a path towards being a low carbon energy producer. “They need to take a longer term view,” he said. “You can’t work with the instruments you used to have five years ago, and look just at the first few years in which nothing is going to change. That’s the problem.”
To make credit ratings comparable across issuers, and so that each issuer can have just one rating for all its debt, the agencies look at credit risk over a time horizon of up to five years. But that can mean they attach too little weight, critics say, to issues such as climate change, whose worst effects will happen later, but for which remedial action must be taken now.
“Today EDF is issuing a 50 year bond,” said de Paoli. “If we don’t stay below 1.5C I don’t think the world will be there in 2070.”
Considerations of climate change and sustainability ought to become fundamental to all business decisions and investment analyses, he argued.
“I want in the future that sustainable should disappear from the definition — it’s just the new economy,” de Paoli said. “That’s why we are shouting to the rating agencies to wake up. To understand that we are putting in the pieces of the new economy, not to do some sustainable product.”