Endesa SA

Executive Summary

Investment Thesis (3 Sentences)

Endesa is Spain's largest electric utility with a regulated distribution network serving 22 million people and 10+ million customers, providing predictable cash flows and defensive characteristics. The company delivered exceptional 2024 results (net income +154%) as energy markets normalized post-crisis, with strong deleveraging (1.8x net debt/EBITDA) and dividend growth (+32%). While trading at fair value (~17x P/E) with limited upside, the 4.3% yield and regulated utility profile make it a reasonable income holding, though Enel's 70% control limits minority shareholder influence.

Key Metrics Dashboard

Decision & Sizing

Primary Catalyst & Timeline

• Catalyst: Continued energy transition + potential regulatory clarity on grid remuneration (2025-2026)
• Timeline: Dividend payment July 2025; regulatory update expected H1 2025

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PHASE 0: Opportunity Identification (Klarman)

Why Does This Opportunity Exist?

Assessment: The opportunity was primarily due to the temporary energy market dislocation in 2022-2023. The market has now largely recognized the recovery (stock +45% YTD), reducing the opportunity. Current valuation is fair, not cheap.

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PHASE 1: Risk Analysis (Inversion Thinking)

"All I want to know is where I'm going to die, so I'll never go there." - Munger

Top 3 Ways This Investment Could Fail

1. Regulatory Risk (Probability: 30% | Impact: -25%)

• Risk: Spanish government changes regulatory framework unfavorably
• Mechanism: Distribution remuneration cuts, windfall taxes, price caps
• Historical Evidence: Spain has history of retroactive regulatory changes (2013-2014 cuts)
• Recent Example: 1.2% extraordinary levy in 2023-2024 (now expired)
• Mitigation: Enel's political influence; Spain needs investment for energy transition
• Expected Loss: 30% × 25% = 7.5%

2. Enel Control Risk (Probability: 20% | Impact: -20%)

• Risk: Enel extracts value at expense of minority shareholders
• Mechanism: Related party transactions, unfavorable dividends, asset transfers
• Historical Evidence: Some concerns about intercompany arrangements
• Mitigation: Listed company with regulatory oversight; Enel needs capital markets access
• Expected Loss: 20% × 20% = 4%

3. Energy Transition Execution Risk (Probability: 25% | Impact: -30%)

• Risk: Fails to execute renewables transition competitively
• Mechanism: Stranded thermal assets, higher capex than planned, technology shifts
• Current Status: 47% renewable capacity, targeting significant expansion
• Mitigation: Already well-positioned vs peers; regulated distribution provides buffer
• Expected Loss: 25% × 30% = 7.5%

Bear Case Summary (Short Thesis)

"Endesa is a captive subsidiary of Enel with 70% control, trading at fair value with no margin of safety. Spain's regulatory history is hostile to utilities - expect future windfall taxes and rate cuts. The 2024 results are peak earnings as energy prices normalize lower. Minority shareholders get the dividend scraps while Enel controls the strategic direction. At 17x earnings with limited growth, you're paying full price for a utility with governance discount deserved."

Inversion Questions

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PHASE 2: Financial Analysis

Return Metrics

ROE Analysis (5-Year)

*Estimated

Normalized ROE: ~14-15% (excluding 2023 extraordinary impacts)

Owner Earnings Calculation (2024)

Net Earnings:                    €1,888M
+ Depreciation/Amortization:     ~€1,800M (estimated)
- Maintenance CapEx:             ~€1,200M (estimated)
- Working Capital Changes:       ~€200M (estimated)
= Owner Earnings:                ~€2,300M

Owner Earnings per Share = €2,300M / 1,058.75M = €2.17

Valuation Trinity

1. Asset Value (Regulated Utility Approach)

For regulated utilities, Regulatory Asset Base (RAB) is key:

Estimated RAB: ~€20-25B (distribution + generation)
RAB multiple: 1.0-1.3x typical for Spanish utilities
Implied Equity Value: €20-25B × 1.2 - €9.3B net debt = ~€15-21B
Per Share: €14-20

Assessment: Current price €30.65 trades at premium to asset value - typical for quality utilities

2. Going Concern Value (DCF Conservative)

Assumptions:

• Owner Earnings Year 0: €2,300M
• Growth Years 1-5: 2% (regulated, inflation-linked)
• Growth Years 6-10: 1.5%
• Terminal Growth: 1%
• Discount Rate: 8% (EUR utility)

DCF Value (10-year):
Year 1-5: €2,300M growing at 2% = €2,346, €2,393, €2,441, €2,490, €2,540
Year 6-10: Growing at 1.5%
Terminal Value = €2,700M × 1.01 / (0.08 - 0.01) = €38,957M
PV of Cash Flows + Terminal = ~€11,200M + ~€18,000M = €29,200M

Intrinsic Value = €29,200M / 1,058.75M = €27.58 per share

Margin of Safety: (€27.58 - €30.65) / €27.58 = -11% (Premium to DCF)

3. Dividend Discount Model (Utility Appropriate)

Current Dividend: €1.32
Dividend Growth Rate: 3% (long-term)
Required Return: 8%

DDM Value = €1.32 × 1.03 / (0.08 - 0.03) = €27.19 per share

4. Relative Valuation

Assessment: Trading in line to slight premium vs peers on P/E, justified by strong balance sheet.

Valuation Summary

Intrinsic Value Estimate: €27-30 per share Current Price vs IV: Trading at or slightly above fair value

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PHASE 3: Moat Analysis

Moat Sources

Moat Quantification

Distribution Network (Strongest Moat):

• 320,329 km of network - cannot be replicated
• Serves 22 million people in regulated territories
• Remuneration set by regulator - predictable returns
• ~40% of EBITDA from regulated distribution

Generation Assets:

• 21,449 MW capacity - significant but not unique
• 47% renewable - growing
• Nuclear assets provide baseload (but aging)
• Competitive in wholesale market

Moat Durability Assessment

10-Year Moat Trajectory: Stable to slightly widening (distribution monopoly durable)

Moat Rating: MODERATE-HIGH

Distribution monopoly is very strong; generation competitive but well-positioned. Overall moat is durable for utility sector.

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PHASE 4: Management & Incentive Analysis

Parent Company Control

Capital Allocation (2024)

Note: FCF exceeds uses due to working capital benefits

Enel Relationship Assessment

Positives:

• Strategic backing from major European utility
• Access to Enel's technology and expertise
• Credit strength benefits from parent
• Aligned on energy transition

Concerns:

• Minority shareholders have limited influence
• Potential for value extraction via related party transactions
• Dividend policy set by Enel's needs
• CEO serves Enel's interests first

Insider Activity

Limited visibility - Enel CEO recently increased personal stake (Nov 2024)

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PHASE 5: Catalyst Analysis

Potential Catalysts

No Strong Near-Term Catalyst

The 2024 recovery is already reflected in the +45% YTD price move. Future catalysts are incremental rather than transformative.

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PHASE 6: Decision Synthesis

Graham's 7 Criteria Assessment

Graham Quality: 3.5/7 - Does not meet strict Graham criteria (P/E and P/B too high)

Buffett Quality Criteria

Buffett Quality: 3.5/5 - Good quality utility

Megatrend Resilience Score

Total Score: 0 | Tier: T3 (Adaptable)

Expected Return with Probability Tree

5-Year Expected Return: +29% (~5.3% annualized + 4% dividend = ~9-10% total return)

Position Sizing

Current position: 14.95% of portfolio

Assessment: Position is overweight for a:

• Fair value / slight premium stock
• Controlled subsidiary (governance discount warranted)
• Single-country utility (concentration risk)
• T3 megatrend tier

Recommendation: Consider trimming toward 10-12% allocation

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Price Targets & Recommendation

┌─────────────────────────────────────────────────────────────────┐
│                     INVESTMENT RECOMMENDATION                    │
├─────────────────────────────────────────────────────────────────┤
│ Company: Endesa SA                   Ticker: ELE                │
│ Current Price: €30.65     Date: December 24, 2024               │
├─────────────────────────────────────────────────────────────────┤
│ VALUATION SUMMARY                                                │
│ ┌─────────────────────────┬─────────────┬─────────────────────┐ │
│ │ Method                  │ Value/Share │ vs Current Price    │ │
│ ├─────────────────────────┼─────────────┼─────────────────────┤ │
│ │ DCF (Conservative)      │ €27.58      │ -11% (premium)      │ │
│ │ DDM (3% growth)         │ €27.19      │ -13% (premium)      │ │
│ │ EV/EBITDA (8x)          │ €31.50      │ 3% MOS              │ │
│ │ Owner Earnings (12x)    │ €26.04      │ -18% (premium)      │ │
│ │ Owner Earnings (14x)    │ €30.38      │ -1% (premium)       │ │
│ └─────────────────────────┴─────────────┴─────────────────────┘ │
│                                                                  │
│ INTRINSIC VALUE ESTIMATE: €28 (rounded weighted average)        │
│ CURRENT MARGIN OF SAFETY: -9% (trading at premium)              │
├─────────────────────────────────────────────────────────────────┤
│ RECOMMENDATION:  [ ] BUY  [x] HOLD  [ ] SELL  [ ] WAIT          │
│                  Consider TRIM to reduce concentration          │
├─────────────────────────────────────────────────────────────────┤
│ BUY PRICE (Strong):         €19.60 (30% below IV)               │
│ ACCUMULATE PRICE:           €22.40 (20% below IV)               │
│ FAIR VALUE:                 €28.00 (Intrinsic Value)            │
│ TAKE PROFITS PRICE:         €33.60 (20% above IV)               │
│ SELL PRICE:                 €42.00 (50% above IV)               │
├─────────────────────────────────────────────────────────────────┤
│ POSITION SIZE: 14.95% (current) - consider trim to 10-12%      │
│ CATALYST: Regulatory clarity H1 2025; dividend continuation     │
│ PRIMARY RISK: Regulatory intervention; Enel control             │
│ SELL TRIGGER: Dividend cut >30%; new windfall tax; P/E >22x    │
└─────────────────────────────────────────────────────────────────┘

Explicit Sell Triggers

1. Thesis Break: Spain imposes permanent windfall tax or materially cuts distribution remuneration
2. Moat Erosion: Distribution monopoly threatened by regulatory change
3. Governance Failure: Enel proposes transaction clearly unfavorable to minorities
4. Valuation: Price exceeds €42 (50% above fair value)
5. Financial: Net debt/EBITDA exceeds 4x; dividend cut >30%

What I Will NOT Sell On

• Short-term energy price volatility
• Temporary regulatory noise (elections, political posturing)
• Market panic unrelated to company fundamentals
• Minor earnings miss in single quarter

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Monitoring Metrics

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Psychology Check

Munger's Final Test

1. Circle of Competence: Can explain - utility that generates and distributes electricity in Spain
2. Variant Perception: No strong variant view - stock is fairly valued
3. Humility Check: If regulatory environment turns hostile, thesis is challenged
4. Inversion Final: If -50% tomorrow, would I add cautiously (regulated utility likely to survive)

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Sources Used & Data Extracted

API Data Retrieved

Web Sources Consulted

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Conclusion

Endesa is a quality regulated utility trading at fair value. The 2024 recovery was impressive but is now priced in. As an income holding with a 4.3% yield and defensive characteristics, it's acceptable to hold. However, the current 14.95% allocation is arguably too concentrated for a controlled subsidiary with governance limitations.

Final Verdict: HOLD. Collect dividends. Consider trimming to 10-12% allocation on strength (above €33).

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Analysis completed December 24, 2024