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Stock Strategist Industry Reports

EDF's Moat Remains Intact Despite Structural Changes

With power market reform in the wings and big questions around multi-billion-dollar investments in nuclear stations, EDF has some big challenges on its hands. But we believe its expertise, political clout, and size will keep the group on track and provide profitable growth for investors.

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 Electricite de France (EDF) faces challenges and changes in Europe, especially in France following Francois Hollande's election to the presidency and increasing Socialist Party clout. EDF's French businesses constitute 60%-70% of earnings before interest, taxes, depreciation, and amortization, so political turnover could have a significant impact. Structural changes in France's heavily regulated electricity generation market--where EDF retains an effective monopoly--have been in the pipeline for years. EDF's huge nuclear fleet could require tens of billions of euros of investment, which may not be fully recovered. During his campaign, Hollande made anti-nuclear comments and threatened plant closures. EDF also could lose ownership of its hydro resources. In short, EDF's primary cash flow drivers could undergo radical change during the next three to five years--or not.

We think the uncertainty is reflected in EDF's flagging share price, trading at a 25% discount to our fair value estimate and at a discount to many of its European utility peers with a 5.5 times forward enterprise value/EBITDA multiple and 8.5 times forward P/E. We recognize the potential for a paradigm shift in the company's business model, but ultimately we believe EDF will retain ownership of France's nuclear fleet and much of its hydro fleet. These low-cost generation assets are the backbone of the company's narrow economic moat. Stormy seas in Europe may persist, and EDF's fundamentals could weaken in the near term, given its concentrated exposure relative to some of its peers. But we think EDF will continue to generate some of the strongest returns on invested capital in its peer group during the next five years.

Mark Barnett does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.