barcap - uk big 6 utilities - 20111102

7/29/2019 BarCap - UK Big 6 Utilities - 20111102

http://slidepdf.com/reader/full/barcap-uk-big-6-utilities-20111102 1/65

EQUITY RESEARCH 2 November 20

UK UTILITIES

Time for a price war?

Our analysis in this report argues that two factors could shift the balance of power

between the “Big 6” UK utilities: declining household energy demand, and the shift in

profitability from old fossil fuel generation to cleaner generation. The winners will

have the potential to compete more aggressively in downstream energy supply and

gain market share. The losers could see retail margins squeezed and customer

numbers decline. We believe investors should steer clear of this potential price war,

and focus instead on assets which benefit directly from the changing shape of the

UK utilities industry. Our top picks are Drax (we upgrade to 1-OW) and National Grid.

We downgrade Centrica to 3-UW, and initiate coverage of SSE with a 2-EW rating.

The household energy demand squeeze. Our analysis finds that growing energy

efficiency and pressure on disposable income could drive annual declines in UK

household gas and electricity consumption of 3.7% and 2.4% per annum respectively

to 2015. Centrica appears most exposed to this risk, due to its high gas market share.

The great generation profit transfer. A surge in new gas capacity, an acceleration in

biomass build, offshore wind, potential nuclear life extensions and falling energy

demand are likely to leave owners of older coal and gas capacity struggling to cover

fixed costs, while cleaner generators profit. Drax is now potentially a key beneficiary,

while SSE’s high fossil fuel exposure could act as a drag on earnings.

Time for a price war? We analyse the relative competitive positions of the Big 6. We

find that EdF Energy could see a net increase in relative earnings power of up to£37/customer over the next three years. Centrica could see a relative decrease in

earnings power of up to £18/customer. We believe this divergence in fortunes could be

the trigger for increased price competition. In particular, we believe EdF Energy (and

RWE npower) have both the means and motivation to grab downstream market share.

We see evidence that they are already pricing more aggressively.

Avoid downstream exposure. Centrica is the biggest loser in our analysis. We see risk

of 7% consensus EPS downgrades. We also believe Centrica could experience a P/E de-

rating, leading it to trade at a substantial discount to SOTP. We cut our price target to

£2.60 and downgrade Centrica from 1-OW to 3-UW. On the other hand, Drax’s

potential to convert to biomass confers significant option value. We upgrade from 3-

UW to 1-OW with a £6.75 price target.

We move European Utilities to Neutral. The UK joins the list of regions we see with

weak fundamentals. We take this opportunity to cut our sector stance to 2-Neutral.

Barclays Capital does and seeks to do business with companies covered in its research reports. As aresult, investors should be aware that the firm may have a conflict of interest that could affect theobjectivity of this report.

Investors should consider this report as only a single factor in making their investment decision.

This research report has been prepared in whole or in part by research analysts based outside the USwho are not registered/qualified as research analysts with FINRA.

PLEASE SEE ANALYST(S) CERTIFICATION(S) AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 56.

SECTOR UPDATE

European Utilities

2-NEUTRALfrom 1-Positive

For a full list of our ratings, price target andearnings changes in this report, please seetable on page 2.

European Utilities

Peter Bisztyga

+44 (0)20 3134 4763

[email protected]

Barclays Capital, London

Monica Girardi

+39 02 6372 [email protected]


Julie Arav

+44 (0)20 7773 1722

[email protected]


Susanna Invernizzi

+39 02 6372 2681

[email protected]


Harry Wyburd+44 (0)20 3134 2115

[email protected]


Wen Du

+44 (0)20 7773 2317

[email protected]


U.S. Power

Daniel Ford, CFA

1.212.526.0836

[email protected]

BCI, New York

Ross A. Fowler, CFA

1.212.526.3432

[email protected]

BCI, New York



Barclays Capital | UK Utilities

2 November 2011 2

Summary of our Ratings, Price Targets and Earnings Changes in this Report (all changes are shown in bold)

Company Rating Price Price Target EPS FY1 (E) EPS FY2 (E)

Old New 31-Oct-11 Old New %Chg Old New %Chg Old New %Chg

European Utilities 1-Pos 2-Neu

Centrica (CNA LN / CNA.L) 1-OW 3-UW 2.97 3.70 2.60 -30 0.27 0.26 -4 0.31 0.27 -13Drax Group (DRX LN / DRX.L) 3-UW 1-OW 5.43 3.20 6.75 111 0.47 0.52 11 0.35 0.51 46

SSE (SSE LN / SSE.L) N/A 2-EW 13.44 N/A 12.35 - N/A 1.12 - N/A 1.23 -

Source: Barclays Capital Share prices and target prices are shown in the primary listing currency and EPS estimates are shown in the reporting currency.

FY1(E): Current fiscal year estimates by Barclays Capital. FY2(E): Next fiscal year estimates by Barclays Capital.

Stock Rating: 1-OW: 1-Overweight 2-EW: 2-Equal Weight 3-UW: 3-Underweight RS: RS-Rating SuspendedSector View: 1-Pos: 1-Positive 2-Neu: 2-Neutral 3-Neg: 3-Negative

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=CNA.L

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=DRX.L

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=SSE.L

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=SSE.L

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=DRX.L

http://my.barcapint.com/ERG/displayCompany.jsp?ticker=CNA.L




2 November 2011 3

CONTENTS

EUROPEAN UTILITIES COMPARABLE ANALYSIS.......................................................................... 4 THE SHIFTING BALANCE OF POWER.............................................................................................. 5 THE HOUSEHOLD ENERGY DEMAND SQUEEZE ........................................................................... 9 THE GREAT GENERATION PROFIT TRANSFER............................................................................ 12 TIME FOR A PRICE WAR?................................................................................................................ 18 COMPANY SECTION ........................................................................................................................ 23 Centrica – not so safe after all............................................................................................................... 25 Drax – from dark to bark ........................................................................................................................ 35

SSE – still struggling for momentum ................................................................................................... 43 National Grid – proactive asset management started ..................................................................... 53




2 November 2011 5

THE SHIFTING BALANCE OF POWER

Our analysis in this report argues that two factors could shift the balance of power

between the “Big 6” UK utilities over the next two to three years: the twin challenges of

declining household energy demand and the shift in profitability from old fossil fuel

generation to cleaner generation. There will be winners and losers. The winners willhave the potential to compete more aggressively in downstream energy supply and gain

market share. Specifically, we identify EdF Energy and RWE npower as having the

capacity and motivation to compete more aggressively, to the detriment of Centrica, SSE

and E.On Energy. We believe investors should steer clear of this battle, and focus

instead on assets which benefit directly from the changing shape of the UK utilities

industry: such as Drax’s biomass conversion project, and National Grid’s UK electricity

transmission division.

The changing shape of the UK utilities sector

UK energy bills have made headline-grabbing news, with politicians and the public

bemoaning the lack of competition. We believe this could be about to change, driven by a

shift in the balance of power between the Big 6 UK utilities:

The household energy demand squeeze. If improvements in household energy

efficiency continue, we would expect household gas and electricity consumption to

decline by around 2.1% and 0.7% per annum respectively. However, we estimate these

declines could accelerate to 3.7% and 2.4% per annum respectively if household real

incomes remain under pressure. We expect Centrica to be more negatively impacted

than its competitors given its high volume share of the residential gas market. We

estimate it could see a demand decline that amounts to a loss of EBIT margin of

£17/customer over 2012-15E – nearly half of its 2011E margin of £38/customer.

The great generation profit transfer. Our analysis shows that a surge in new Combined

Cycle Gas Turbine (CCGT) capacity, an acceleration in biomass build, potential nuclear

life extensions and falling energy demand will leave owners of older coal and gas

capacity struggling to cover fixed costs. The winners are likely to be those with most

Time for a price war?

Figure 1: Energy consumption per household (kWh) Figure 2: UK power generation capacity (GW)

10,000

12,000

14,000

16,000

18,000

20,000

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

2 0 1 2 E

2 0 1 4 E

2,500

3,000

3,500

4,000

4,500

5,000

Gas Electricity

0

20

40

60

80

100

2009 2011E 2013E 2015E 2017E

Biomass

Wind

Hydro

Oil

OCGT

CHP

CCGT

Hard Coal

Nuclear

Source: Barclays Capital, ONS. Source: Barclays Capital, National Grid.




2 November 2011 6

exposure to cleaner generation, or those involved in connecting these assets to the

transmission grid. In our view, Drax and National Grid benefit the most directly.

However, SSE’s significant old fossil fuel exposure is likely to act as a drag on earnings,

despite its renewables and transmission exposure.

Time for a price war? We estimate EdF Energy could see a net increase in generation

and supply earnings power of £31-37/customer over the next three years, driven by itshigh upstream nuclear exposure and low downstream gas exposure. RWE npower and

ScottishPower also have better than average profit momentum in generation. On the

other hand, we believe Centrica could see a decrease of £10-18/customer in its net

generation and supply earnings power as a result of the declining household energy

demand and weaker profits for its CCGT fleet. For SSE and E.On Energy the net negative

impact could be as high £10/customer and £16/customer respectively. This divergence

in fortunes could be the trigger for increased price competition. In particular, we believe

EdF Energy and RWE npower have the motivation to grab downstream market share to

rebalance their “long” generation exposure. Indeed, we see evidence that they are

already pricing more aggressively. We believe investors should steer clear of this battle,

as it is likely to mean lower margins for the whole downstream industry.

Figure 3: Net shift in generation and supply EBITDA (£ per residential single fuel

customer, 2012-15E)

(10 )

37

(8 )

510

(7 )

0

(18 )

31

(16 )

(2 )

3

(14 )(7 )

(30 )

(20 )

(10 )

0

10

20

30

40

50

C N A

E D F

E . O N

R WE

I B E

S S E

" B i g 6 "

A v e r a g e

Slow Demand Decline Scenario Fast Demand Decline Scenario

EdF’s exposure to clean

generation leaves it positioned to

compete more aggressively in

the downstream retail market

Source: Barclays Capital.

We see two principal risks to our UK utilities industry views:

Utilities fail to compete more aggressively. Our cautious stance on the UK downstream

retail energy market may prove to be unfounded should the Big 6 utilities fail to compete

more aggressively on price, despite the potential for a clear shift in the balance of power.

However, if this were to be the case, we would expect regulatory or politicalintervention, in the form of a Competition Commission investigation.

Politicians withdraw from green energy policies. Concerns about the impact that the

transition to cleaner generation will have on household energy bills have raised

questions about the UK Government’s commitment to its renewables and carbon

reduction goals. This raises this risk that this, or a future, government reneges on

policies such as the Renewables Obligation and the carbon price floor. Indeed, there are

already apparent divisions within the Coalition, with the Chancellor, George Osborne,

seeming to distance himself from the UK’s ambitious renewables and carbon reduction




2 November 2011 7

targets1, and the Prime Minister’s new energy adviser questioning the Department of

Energy and Climate Change’s (DECC) calculations about the impact of renewables policy

on energy bills2. That said, recent comments by the Committee on Climate Change,

which sets the legally binding targets for business, said that it would be “very difficult”

to change the targets3. In any case, green energy policy is a central tenet of the UK

Government’s coalition agreement, and we see little probability of these targets being

abandoned on a 2-3 year view. Instead, we believe the key risk is that politicians force

the downstream energy suppliers to share some of the burden, for example through

windfall taxation.

Stock recommendations

Centrica (3-UW, £2.60 PT) – not so safe after all. Over the past few months we have

argued that Centrica is a relative safe haven. Its defensive characteristics have been

borne out in 14% outperformance relative to the Stoxx 600 since May. Whilst its

financial position remains robust, the economic and retail market environment is

evolving rapidly. In particular, with declines in energy demand accelerating, we now

think both sides of Centrica’s upstream hedge could come under pressure. We believeits competitive advantage in the UK retail market will fade, and that persistently weak

spark spreads will lead to disappointing power generation profits in 2012/13E. We also

see increasing downside risks for BGS, BGB and Direct Energy given the deteriorating

economic environment. We cut our 2012-14E EPS forecasts to 7% below IBES

consensus on average. In the current market environment, we doubt Centrica can trade

at our revised SOTP valuation of £3.29. Given the deteriorating fundamentals, we

believe Centrica’s shares could instead derate towards their historical P/E discount to

the Stoxx Utilities index of -0.5, implying 12% share price downside. We downgrade

Centrica from 1-OW to 3-UW with a new £2.60 price target.

Drax (1-OW, £6.75 PT) – from dark to bark. Drax is a key beneficiary of the current UK

Government’s support for cleaner generation. Following the proposed increase inRenewable Obligation Certificate (ROC) support, we now believe it is highly likely that

Drax will proceed with plans to convert to 50% biomass co-firing. We believe this

completely transforms the equity story of Drax, securing its position in the UK power

market for the long term. A combination of the carbon tax and Renewables Obligation

(RO) support should underpin progressively rising earnings. Over the medium term, our

analysis suggests that Drax has the potential to return significant amounts of cash to

investors. Numerous uncertainties remain, which means Drax remains a risky stock, in

our view. Nonetheless we consider the upside potential to be considerable, particularly if

Drax opts to convert the plant to 100% biomass in the future. We upgrade from 3-UW

to 1-OW and set a new price target of £6.75.

1 “We’re not going to save the planet by putting our country out of business … so let's at the very least resolve that we’re going to cut our carbon emissions no slower but also no faster than our fellow countries in Europe. That’s what I've insisted on in the recent carbon budget” , George Osborne’s speech at the Conservative Party conference, 3October 2011.

2 “Over time it is clear that the impact of our policies on consumer bills will become significantly greater … four policies

stand out as having the most significant impact on household energy bills: carbon pricing (both out own carbon pricefloor and the EU emissions trading scheme), the new Energy Company Obligation, our Electricity Market Reform

package and the Renewables Obligation” , Letter to David Cameron from advisers Ben Moxham and Gila Sacks on theimpact of energy and climate policies on consumer energy bills, The Telegraph, 5 September 2011.

3 “Energy giants told carbon targets are here to stay” , The Times, 1 November 2011.




2 November 2011 8

SSE (2-EW, £12.35 PT) – still struggling for momentum. We see deteriorating

fundamentals in SSE’s generation and supply business. Its large ageing coal and gas

fleet is likely to struggle to cover its fixed costs once free CO2 permits expire, and it has

less earnings momentum in its UK cleaner generation fleet than some of its competitors.

As a result, we believe SSE will be at a competitive disadvantage in the UK retail market,

which could see its market share and margins come under pressure. However, risk to

EPS is mitigated by SSE’s exposure to UK regulated networks, specifically electricity

transmission. We see just 2% downside to consensus estimates. And whilst we expect a

P/E de-rating, the downside is partially offset by a 5.9% yield and potential for 6-7%

dividend growth. We consider the risks to SSE’s shares, therefore, to be moderate when

compared to the risks we see across other integrated utility names. We initiate coverage

with a 2-EW recommendation and a £12.35 price target.

National Grid (1-OW, £6.80 PT) – proactive asset management started. For exposure

to UK electricity transmission, our preferred play remains National Grid. The RIIO

regulatory review (Revenue = Incentives + Innovation + Outputs), which will define new

tariffs from April 2013, enters into its central phase in the second half of next year.

Preparing for that, the company has already started to follow a strategy of asset

rationalisation, which will result, in our view, in a cleaner structure and more focused

business lines. In the medium term, we see two main drivers of performance for the

stock: 1) the implementation of a regulatory framework which should stimulate rapid

RAV growth; 2) a financing strategy with ongoing asset rationalisation aimed at

achieving the highest possible blended return on the company’s invested capital.




2 November 2011 9

THE HOUSEHOLD ENERGY DEMAND SQUEEZE

The first of the twin challenges facing the Big 6 UK utilities is that of falling residential

energy demand. If improvements in household energy efficiency continue in line with the

trend over the past five years, and household real incomes start to recover, we would

expect household gas and electricity consumption to continue to decline by around 2.1%and 0.7% per annum respectively. However, if there was little or no growth in real

incomes, we would expect the declines to be 3.7% and 2.4% per annum respectively.

Drivers of falling energy demand

Domestic gas and electricity consumption had been rising steadily by 1.7% p.a. for decades

up until around 2004/05 (Figure 4), driven by rising disposable incomes and increasing

penetration of gas for domestic central heating. However, the past few years have seen

household demand for both electricity and gas decline in absolute terms. For reference,

households account for about 35% of total UK electricity consumption and 60% of UK non-

power generation gas consumption.

In our view, this trend of declining household energy consumption has the potential to

accelerate, driven by two factors:

Rising energy efficiency. Domestic energy intensity4 has been declining for many years

(Figure 5). However, the trend accelerated for gas after 2004, coinciding with the

second phase of the Energy Efficiency Commitment (EEC). This increased theobligations on energy suppliers to achieve improvements in household energy efficiency

via measures relating to insulation, lighting, appliances and heating. Since then the UK

Government has introduced a number of follow-up measures, including the Carbon

Emissions Reduction Target (CERT), Community Energy Saving Programme (CESP) and,

from late 2012, the Energy Company Obligation (ECO) and Green Deal. The latter aims

to create a new financing framework with savings recovered through energy bills,

avoiding the need for consumers to pay upfront costs. In aggregate, the supplier

4 Domestic energy intensity is defined as energy consumption per unit of household disposable income.

Energy efficiency and falling real

incomes put pressure on

demand

Figure 4: Trends in domestic energy consumption (TWh) Figure 5: Domestic energy intensity index* (1987 = 100)

50

100

150

200

250

300

350

400

450

1 9 7 0

1 9 7 4

1 9 7 8

1 9 8 2

1 9 8 6

1 9 9 0

1 9 9 4

1 9 9 8

2 0 0 2

2 0 0 6

2 0 1 0

50

60

70

80

90

100

110

120

130

Gas (Left Axis) Electrici ty (Right Axis)

30

40

50

60

70

80

90

100

110

1 9 8 7

1 9 8 9

1 9 9 1

1 9 9 3

1 9 9 5

1 9 9 7

1 9 9 9

2 0 0 1

2 0 0 3

2 0 0 5

2 0 0 7

2 0 0 9

2 0 1 1 E

2 0 1 3 E

2 0 1 5 E

Gas Electricity

Source: Barclays Capital, DECC Statistics. Source: Barclays Capital.

* Domestic energy intensity is measured as annual energy consumption per

household, per unit of real disposable income.




2 November 2011 10

obligations – alongside other measures such as building regulations, the roll-out of

smart meters and products standards – are expected by DECC (The Department of

Energy and Climate Change) to deliver 67TWh of annual energy savings by 2016. This

equates to around 13% of current household annual energy consumption of c500TWh.

Figure 6: Expected UK household energy savings

2010E 2016E

TWh MtCO2e TWh MtCO2e

Supplier Obligations 26.7 7.6 61.4 14.8

Building Regulations 22.4 4.3 40.9 7.8

Product Standards 1.4 0.7 8.5 3.8

Smart Meters/In Home Displays - - 5.3 1.4

Renewable Heat Incentive - - 1.3 1.2

Warm Front 8.0 2.4 8.4 2.6

Total 58.5 14.9 125.9 31.7

Source: UK Report on Articles 4 and 14 of the EU End-use Efficiency and Energy Services Directive (ESD) , DECC, July 2011.

Pressure on household disposable income. Although increased efficiency has caused

household energy consumption to decline in recent years, the rate of decline has been

partially mitigated by continued growth in real disposable incomes. However, this may

not be the case going forward. UK households are currently facing a decline in real

disposable income for the first time in 30 years. This has coincided with a 22% increase

in household energy bills over the last 12 months. As a result, we estimate that the

average duel fuel bill now amounts to 7.9% of per capita gross disposable household

income, compared to 6.7% a year ago, and 4.6% in 2004.

The result is that households are cutting back on energy usage: in 1H11, SSE reported

that underlying electricity consumption had fallen by 2.9% y/y, and that underlying gas

consumption had fallen by 5.8%.

Our economists currently expect real household disposable income to decline by 1.7%

in 2011, and then to recover by 1.7% per annum on average to 2015. Not only is this

below the average annual growth of 2.1% over 1999-2009, our economists

acknowledge that there are downside risks to their forecasts from persistently high

inflation and rising unemployment.

If improvements in household energy efficiency continue in line with the trend over the past

five years, and our economists are correct about real income growth, we would expect

household gas and electricity consumption to continue to decline by around 2.1% and 0.7%

per annum respectively. However, if there was little or no growth in real income, we would

expect the declines to be 3.7% and 2.4% per annum respectively (Figure 8).




2 November 2011 11

Figure 7: Real household disposable income (£bn) Figure 8: Energy consumption per household (kWh)

6.4%5.7%

7.7%7.2%

6.7%

7.9%

4.9%

4.6%

800

840

880

920

960

1,000

2 0 0 4

2 0 0 5

2 0 0 6

2 0 0 7

2 0 0 8

2 0 0 9

2 0 1 0

2 0 1 1 E

2 0 1 2 E

2 0 1 3 E

2 0 1 4 E

2 0 1 5 E

3%

4%

5%

6%

7%

8%

9%

10%

Real Household Disposable Income (£bn, Left Axis)Dual Fuel Bill as % Gross Household Income (Right Axis)

10,000

12,000

14,000

16,000

18,000

20,000

2 0 0 0

2 0 0 2

2 0 0 4

2 0 0 6

2 0 0 8

2 0 1 0

2 0 1 2 E

2 0 1 4 E

2,500

3,000

3,500

4,000

4,500

5,000

Gas Electricity

Source: Barclays Capital, ONS. Source: Barclays Capital, ONS.




2 November 2011 12

THE GREAT GENERATION PROFIT TRANSFER

The second of the twin challenges facing the Big 6 UK utilities is the expected shift in

profitability from old fossil fuel generation to clean generation. Our analysis shows that

a surge in new CCGT capacity, an acceleration in biomass build, potential nuclear life

extensions and falling energy demand will leave owners of older coal and gas capacitystruggling to cover fixed costs. The winners are likely to be those with most exposure to

new CCGT, nuclear generation, wind and biomass.

The transforming power generation market

We believe that the UK power market will become increasingly tough for owners of existing,

ageing coal and CCGT generation, driven by a number of different factors:

9GW of highly efficient new CCGTs. One of the key factors driving down spark spreads

on existing CCGTs in the UK has been new build of highly efficient plant. State-of-the-art

new gas plant, such as RWE’s 2.2GW Pembroke CCGT, due to commission during 2012,

have thermal efficiencies of 59% (gross calorific value). This compares to a UK average

of around 52.4% (2010A), while some of the oldest CCGTs opened in the 1990s have

efficiencies below 48%. The higher efficiency of new CCGTs means marginal costs are

some 20% lower than those of the least efficient plant. As a result, these new plants will

sit low down the merit order, displacing less efficient capacity (see Figure 9) and

lowering the cost curve for the whole market. Around 5.6GW of new CCGT capacity

became operational over 2010/11, and we expect a further 3.3GW to commission

during 2012 (see Figure 10). In addition to this, we believe there are around 3GW of

planned new CCGTs that are likely to go ahead and be operational by 2015/16.

Majority of LCPD plant likely to run until 2014/15. During winter 2010/11 much of the

UK’s opted-out5 coal plant was running so hard that it looked then like it would run out

of operating hours during 2012. However, in spite of a substantial increase in clean dark

spreads since the Japanese earthquake in March 2011, load factors of opted-out coal

plant in the UK during summer have been lower than during 2010. As a result, we only

5 This refers to power stations that have opted out of the LCPD and therefore are limited to 20,000 running hoursbetween 2008-15, and have to close thereafter.

The shape of the UK power

market is changing

Figure 9: New CCGT in the UK merit order, 2011E (GW) Figure 10: Cumulative new CCGT capacity (GW)

0

20

40

60

80

100

120

140

0 20 40 60

Capacity (MW)

Oil

GT

CCGT

CHPNuclear

Hydro

Coal

New CCGT

SRMC (£/MWh)

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

2010 2011 2012E 2013E 2014E 2015E 2016E

Operational Under Construction Potential New Build

Source: Barclays Capital. SRMC = Short-Run Marginal Cost Source: Barclays Capital.




2 November 2011 13

expect one plant to close by the end of 2012. Furthermore, RWE has already converted

its Tilbury plant into a 750MW dedicated biomass facility that is expected to operate

until the end of 2015. Indeed, as shown in Figure 12, if all the opted-out plants average

their last 12-month load factor going forwards, only two other plants will close before

2015.

Nuclear life extensions. After 2015, when the opted-out coal plant has shut, we believe

some of the pressure on the UK reserve margin could be relieved by life extensions at

British Energy’s nuclear fleet. This would mitigate upside for spark spreads. Currently,

Hinkley Point B (870MW) and Hunterston B (890MW) are due to close in 2016.

However, we believe that the UK carbon price floor significantly improves the economics

of life extensions. As for new nuclear, we believe that the probability of a new plant

becoming operational before 2020 is slim.

Growth in wind capacity. Our European Clean Technology & Sustainability team

forecast that 11GW of onshore and offshore wind will be added in the UK over the

course of 2011-2015E6. This could displace 3.5GW of CCGT capacity on average during

the year.

In our view, these wind capacity forecasts are relatively conservative: they are derived

from current renewables developers’ pipelines and sit between the low and base case

set out by DECC in its UK Renewable Energy Roadmap in July 2011. The proposed

Renewables Obligation Certificate bandings of 0.9 for onshore wind and 1.8-1.9 for

offshore wind appear be sufficient to ensure these pipelines are delivered 7 . Mott

MacDonald estimate that the levelised cost for onshore wind is around £86/MWh, while

the current 2013 forward power price plus 0.9x ROC buyout price equates to £99/MWh.For offshore wind our forecast 2015 power price plus 1.8-1.9x ROC buyout price

equates to £150-155/MWh versus an estimated levelised cost of £112-146/MWh8. See

Figure 23 for more details.

6 See: Global demand outlook - five-year CAGR wind 10%, solar 8%, Barclays Capital, 15 August 2011.7 Consultation on proposals for the levels of banded support under the Renewables Obligation for the period 2013-17 and the Renewables Obligation Order 2012, DECC, 20 October 2011.8 UK Electricity Generation Costs Update, Mott MacDonald, June 2010.

Figure 11: UK opted-out plant load factor (%) Figure 12: UK opted-out plant estimated closure dates

0%

20%

40%

60%

80%

100%

Aug-09 Feb-10 Aug-10 Feb-11 Aug-11

Average Coal Average Oil

Dec-11 Dec-12 Dec-13 Dec-14 Dec-15

Grain

Ironbridge

Kingsnorth

Didcot AFawley

Littlebrook

Tilbury 1*Tilbury 2*

Ferrybridge C

Cockenzie 1

Cockenzie 2

at Ave. Last 12mth Load at Ave. Last 24mth Load

Source: Barclays Capital, BM Reports. Source: Barclays Capital, BM Reports.




2 November 2011 14

Growth in biomass capacity. Our analysis of current project pipelines suggests thatthere is potential for some 2.6GW of additional dedicated and biomass co-firing capacity

to be added in the UK by 2016, in addition to RWE’s Tilbury plant. The biggest project

within our forecast is Drax’s plan to convert to 50% co-firing capacity by 2015, up from

12.5% currently – equivalent to 1.5GW of additional capacity. The proposed increase in

the ROC banding from 0.5x to 1.0x from 1 April 2013 is likely to be enough, in our view,

for Drax to go ahead with this project. Based on current forward wood pellet prices, we

estimate biomass will be running ahead of all conventional coal and CCGT plant in the

UK merit order (Figure 14).

Falling electricity demand. We have already discussed the potential for residential energy

demand to fall in the UK due to a combination of rising energy efficiency and falling

disposable income. In addition, industrial and commercial electricity demand may come

under pressure if UK economic growth stalls. Figure 15 shows National Grid’s base and low

case forecasts for total UK electricity demand. The low case – which averages at a -1.1%

annual decline in demand – assumes annual growth of 1.4% for GDP, -0.4% for household

disposable income, 1.0% for manufacturing output and 1.4% for non-manufacturing output.

Figure 13: Forecast UK wind and biomass capacity (GW) Figure 14: Biomass in the UK merit order, 2015E (GW)

0.0

5.0

10.0

15.0

20.0

25.0

2010 2011 2012E 2013E 2014E 2015E 2016E

Onshore Wind Offshore Wind

Dedicated Biomass Co-Firing

0

20

40

60

80

100

120

140

0 20 40 60

Capacity (MW)

Oil

GTCCGTCHPNuclearHydroCoalBiomassCo-Firing

SRMC (£/MWh)

Dedicated biomass

DraxOther co-firing

Source: Barclays Capital, DECC RESTATS. Source: Barclays Capital. SRMC = Short-Run Marginal Cost

Figure 15: Forecast total UK annual power demand (TWh) Figure 16: Forecast UK capacity margin (%)

270

280

290

300

310

320

330

2010/11E 2012/13E 2014/15E 2016/17E

Base Low

0%

10%

20%

30%

40%

50%

2009 2011E 2013E 2015E 2017E 2019E

Derated Margin No-Wind Margin

Headline Margin

Source: Seven Year Statement 2010, National Grid. Source: Barclays Capital.




2 November 2011 15

Implications for power prices and spreads

Our analysis of future supply and demand leads us to several conclusions about the outlook

for the UK power generation market:

Spark spreads to stay low until 2014. Clean spark spreads in the UK have been steadily

declining since the start of 2010. The winter 2012/13 spread is currently trading at just

£1.0/MWh (Figure 17). Unfortunately for gas-fired power generators, we would not expect

these to recover before 2014, based on current relative gas and coal prices (Figure 19).

Clean dark spreads to get squeezed from 2013 onwards. Despite growing pressure on

household energy bills, there is no evidence to suggest that the UK Government is

considering abandoning the UK carbon price floor, introduced in the 2011 Budget. We

believe the carbon floor price will have the desired effect of squeezing clean darkspreads (Figure 19) and gradually pushing coal plant to the margin.

Figure 19: UK power price, clean spark spread (CSS) and clean dark spread (CDS) forecasts (£/MWh, net of carbon price floor)

2011E 2012E 2013E 2014E 2015E 2016E

Baseload Power – BarCap Forecast 51.5 52.4 54.6 61.1 64.7 67.8

Baseload Power – Forward Curve* 51.4 53.7 54.7 - - -

Baseload CDS - 36% Efficiency 10.5 14.3 11.5 10.9 9.8 8.9

Baseload CDS - 40% Efficiency (Drax) 14.6 18.1 15.8 15.9 15.3 14.8

Baseload CSS - 49% Efficiency 5.1 2.0 1.5 4.0 4.5 4.7


Source: Barclays Capital, Bloomberg. * Forward curve as at 21 October 2011.

Figure 17: UK seasonal forward clean spark spreads (£/MWh) Figure 18: UK seasonal forward clean dark spreads (£/MWh)

0

5

10

15

20

25

Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

1st Winter 1st Summer2nd Winter 2nd Summer

0

5

10

15

20

25


1st Winter 1st Summer2nd Winter 2nd Summer

Source: Barclays Capital, Bloomberg. Source: Barclays Capital, Bloomberg.

Old fossil fuel plant will struggle

to cover fixed costs




2 November 2011 16

Figure 20: Commodity price assumptions*

2011E 2012E 2013E 2014E 2015E 2016E

Hard Coal - API2 (US$/t) 121.7 116.8 120.4 124.2 127.9 131.8

Oil - Brent Crude (US$/bbl) 111.1 105.1 100.3 100.3 103.3 106.4

Gas - NBP (p/th) 59.9 66.8 68.1 70.2 72.3 74.4

CO2 - EUA (€/t) 13.4 10.9 11.6 12.3 12.6 13.0

CO2 - with price f loor (€/t) 13.4 10.9 15.8 23.3 27.9 31.7

Biomass - Wood Pellet (€/t) 133.9 134.4 138.5 142.6 146.9 151.3

EUR/GBP 1.15 0.87 0.87 0.87 0.87 0.87

GBP/USD 1.61 1.61 1.61 1.61 1.61 1.61

Source: Barclays Capital, Bloomberg. *Commodity prices marked-to-market as at 21 October 2011.

Fossil fuel load factors to decline. As shown in Figure 21, we expect load factors for

older, unhedged CCGT plant to collapse to below 10% over 2012-15E. We only expect

these to pick up as coal plant gets pushed to the margin, by around 2016.

Figure 21: Forecast load factors for UK fossil fuel generation capacity

2012E 2013E 2014E 2015E 2016E 2017E 2018E

Hard Coal - 36% Efficiency 72% 71% 52% 45% 27% 12% 9%

CCGT - 49% Efficiency 10% 7% 8% 5% 18% 26% 23%

Hard Coal - 40% Efficiency (Drax) 80% 80% 80% 80% 80% 65% 59%

CCGT - 58-59% Efficiency 43% 37% 77% 76% 74% 74% 71%


Old fossil fuel plant will not be covering fixed costs. The last free CO2 allocations will

be given to UK fossil fuel generators around February 2012. Once these have been used

up, we believe owners of older capacity will struggle to cover fixed costs. Specifically, we

believe CCGT plant will be unable to cover its fixed costs over the period from 2013-15E,

while old coal plant will become permanently out-of-the money from 2013 onwards.

Indeed, we believe the period from 2013-15E has the potential to be punishing for

generators with significant exposure to old coal and CCGT plant.

Figure 22: Annual EBITDA of 1GW power station, excluding free CO2 (£m)

2010 2011E 2012E 2013E 2014E 2015E 2016E

Hard Coal - 36% Efficiency (24.3 ) (11.0 ) 12.2 (6.7 ) (9.2 ) (17.2 ) (24.4 )

CCGT - 49% Efficiency 14.8 (6.4 ) (9.3 ) (10.3 ) (6.4 ) (8.4 ) 2.2


Transfer of value to cleaner generation. New CCGT, nuclear generation, offshore wind and

biomass (including Drax’s co-firing plans) should all stand to benefit from rising revenues,

driven by a combination of the carbon price floor and the proposed Renewables Obligation

Certificate (ROC) bandings for 2013-2017, as shown in Figure 23. Our modelling shows that

the pass-through of the carbon tax into wholesale power prices should step up in 2017E as

conventional hard coal plant moves to the margin in the UK, substantially improving the

economics of clean generators. Separately, we expect ROC prices to decline due to

accelerating growth in renewable capacity, though the RPI-indexed buyout price should

provide a floor (we think this floor will be reached in 2014/15).




2 November 2011 17

Figure 23: UK clean generation economics*

2011E 2012E 2013E 2014E 2015E 2016E

ROC Price (£) 47.6 46.4 46.6 44.4 44.6 46.0

ROC Buyout Price (£) 38.3 40.2 42.0 43.3 44.6 46.0

Gross Margin - Nuclear (£/MWh) 41.1 41.7 43.7 50.0 53.4 56.3

Gross Margin - Onshore Wind at 0.9x ROC (£/MWh) 96.2 96.3 98.8 103.5 107.5 111.9

Gross Margin - Offshore Wind at 1.8x ROC (£/MWh) 140.8 140.3 143.0 146.0 150.3 156.0

Gross Margin - Offshore Wind at 1.9x ROC (£/MWh) 145.8 145.2 147.9 150.7 155.1 160.9

Gross Margin - Biomass Co-Firing at 1.0x ROC - Drax (£/MWh) 35.4 35.1 35.6 38.2 40.1 42.5

Source: Barclays Capital.* Gross margins calculated using ROC plus LEC at a 5% discount and excluding own fuel use and non-fuel variable costs.

The prospect of capacity closures

Our power price forecasts assume that 12GW of old coal and oil plant will shut by the end of

2015 under LCPD, and that a further 8.4GW of CCGT capacity reaches the end of its useful

life by 2020. In spite of this, we do not expect the UK reserve margin to becomeuncomfortably tight until the end of the decade (Figure 16). The question is whether more

coal and CCGT capacity could be closed from 2012 onwards, since it is not covering fixed

costs, and whether this would have a material impact on power prices and spreads. We

conclude that material closures are unlikely, and that spreads will remain under pressure:

CCGT closure unlikely to have impact on spreads. Some early CCGT closures are highly

likely, in our view. Indeed, Centrica has been reported to be planning closing 570MW of

CCGT capacity in 2012 (Barry and Kings Lynn) 9. However, since we expect the oldest

8.4GW CCGT plant to be operating at sub-10% load factors and to be at the margin only

c3% of the time, its closure should have little impact on the overall power price level.

Value of flexibility. In a market with growing wind capacity, portfolio generators and

those with residential demand to fill may attribute additional option value to flexible

plant that justifies keeping it available. Alternatively, National Grid may directly contract

certain plant (for example, as it has done with three of Centrica’s CCGTs) to remain on

the system.

Biomass conversion. The prospect of an increased banding for enhanced biomass co-

firing, combined with the carbon price floor, make the economics of converting certain

hard coal plant more attractive. As discussed earlier, partial or full conversion of UK coal

plant would have the effect of displacing older gas or unconverted coal plant in the

merit order, putting further pressure on spreads.

9 “Centrica job and plant cuts could spark price increases” , The Times, 17 October 2011.

We do not expect capacity

closures to drive material upside

to spreads




2 November 2011 18

TIME FOR A PRICE WAR?

We believe the twin challenges of declining household energy demand and the shift in

profitability from old fossil fuel generation to clean generation could shift the balance

of power between the Big 6 utilities over the next few years. The winners will have the

potential to compete more aggressively in downstream energy supply and gain marketshare. The losers could see retail margins squeezed and customer numbers decline.

Specifically, we identify EdF Energy, RWE npower, as having the capacity and motivation

to compete more aggressively, to the detriment of Centrica, SSE and E.On Energy.

The household energy demand squeeze – winners and losers

As we concluded earlier, if improvements in household energy efficiency continue in line

with the trend over the past five years, and our economists are correct about real income

growth, we would expect household gas and electricity consumption to continue to decline

by around 2.1% and 0.7% per annum respectively – this is our slow demand decline

scenario. However, if there is little or no growth in real income, we would expect the

declines to be 3.7% and 2.4% per annum respectively – our fast demand decline scenario.

Figure 24 shows the impact the loss of volume would have on £/customer margin over 2012-

15E for each of the Big 6 UK utilities. On average, it amounts to £14 per single fuel customer

account – a negative profit delta of £0.7bn for the industry. Two companies stand out:

British Gas. We expect Centrica’s British Gas division to be more negatively impacted

than its competitors given its high volume share of the residential gas market. Indeed,

under our fast demand decline scenario, we estimate British Gas could see a demand

decline that amounts to a loss of EBIT margin of £17/customer over 2012-15E – nearly

half of its 2011E margin of £38/customer.

EdF Energy. EdF Energy, on the other hand, has the highest proportion of electricity

demand relative to gas demand. This means that in our more bearish scenario it needsto recover £11/customer of margin. Indeed, it is possible that since EdF’s customer base

has a large component of Londoners, it may see less of an impact on demand from

falling disposable incomes.

We would expect the industry as a whole to try and compensate for the loss of demand

through higher retail prices. However, there are two points to consider:

EdF Energy could attempt to gain competitive advantage. EdF Energy is in a position

whereby it can raise dual fuel tariffs by £12/customer less than British Gas in order to

keep profits stable. This is equivalent to £90-100m of EBIT for British Gas. However,

since £12 is only around 1% on the UK’s average dual fuel bill, we suspect British Gas

would rather price higher than lose margin.

Political pressure. We estimate that the industry will need to raise household dual fuel

bills by £28/customer (i.e. double the figure shown in Figure 24) in order to compensate

for lost volumes. Whilst this may not sound like much, for the 5.5m fuel poor

households in the UK this is significant10. This alone may dismay politicians, as will the

fact that households are not seeing the full benefit of energy efficiency in their bil ls.

10 5.5m is the official statistic for 2009, the last available verified data from ONS. In reality, the number of fuel poor inthe UK in Britain in 2012-15E is likely to be significantly higher than this.

Centrica’s exposure to declining

household gas demand is a

competitive disadvantage




2 November 2011 19

Figure 24: Shift in retail EBITDA margin from declining energy demand (£ per residentialsingle fuel customer, 2012-15E)

(9 )(5 ) (6 ) (7 ) (6 ) (7 ) (7 )

(17 )

(11 )(13 ) (14 ) (13 ) (13 ) (14 )

(25 )

(20 )

(15 )

(10 )

(5 )

0

C N A

E D F

E . O N

R WE

I B E

S S E

" B i g 6 "

A v e r a g e



The great generation profit transfer – winners and losers

The UK Government’s green energy policies are designed to promote clean generation at

the expense of older fossil fuel plant. Whilst there is considerable debate about the long-

term viability of these energy policies, given the costs that they ultimately place on the UK

consumer, we do not see the Government reneging on these policies on a 2-3 year view.

We have summarised the impact of this profit transfer for each of the Big 6 in Figure 25 on a

£/customer basis. Our observations are as follows:

The end of free CO2 allocations. We estimate that the Big 6 will see a step-down in

profits in 2013 equivalent to around £20/cust on average, as free CO2 allocations come

to an end. The exception is Centrica, which does not have any coal generation, whichwe expect to take a hit of just £4/cust.

Three potential winners: EdF Energy, RWE npower and ScottishPower (Iberdrola). We

estimate the contribution from EdF’s 80% stake in British Energy and its new 1.3GW

West Burton CCGT should drive a net profit gain of £43/cust over 2012-15E. Despite its

significant exposure to coal generation, RWE should see a gain of £12/cust from the

conversion of Tilbury to biomass, its offshore wind projects and 3.8GW of state-of-the

art new CCGT capacity. Iberdrola’s onshore and offshore wind pipeline is relatively large

compared to its small customer base, and should drive a net gain of £16/cust.

Three potential losers: Centrica Energy, SSE and E.On Energy. Although we expect

Centrica Energy to see its old CCGT profits squeezed over 2012-13E, it does not carry

the burden of old coal plant or material free CO2 allocations. However, it does not have

a significant portfolio of clean generation relative to the size of its 16m customer base.

As a result, we expect the aggregate profitability of its upstream activities (including gas

production) to be relatively flat between 2012-15E. We believe SSE may only see a net

increase in generation profits equivalent to £4/cust between 2012-15E. We believe its

large exposure to renewables will be offset by substantial exposure to old coal and gas

plant and the largest burden from free CO2 permit expiry. Finally, E.On Energy could

face the toughest few years as it has the biggest exposure to coal generation, and a

relatively modest UK clean generation pipeline.

We see Centrica, SSE and E.On

Energy as relative losers




2 November 2011 20

Figure 25: Shift in EBITDA from dirty to clean generation* (£ per residential single fuelcustomer, 2012-15E)

(1 )

(2 )

12 16

(1 )7

43

(40 )

(20 )

0

20

40

60

80

C N A

E D F

E . O N

R WE

I B E

S S E

" B i g 6 "

A v e r a g e

Old Fossil Fuel Generation Clean Generation/Upstream Gas Net


* We have included the expiry of free CO2 permits in the “Old Fossil” category. We have also included EBIT fromupstream gas production (net of production taxes) for Centrica and SSE in the “Clean Generation” category. All analysisassumes zero hedging.

The shifting balance of power: the potential for a price war

Figure 26 quantifies the net impact of declining household energy demand and the shift in

profitability from old fossil fuel generation to clean generation on the earnings power of the Big

6’s generation and supply businesses over 2012-15E. This analysis suggests that there could be a

significant shift in the balance of power between the Big 6 utilities over the next few years:

EdF Energy has the potential to price lead the market We estimate EdF’s UK division could

see a net increase in earnings power of £31-37/customer over the next three years. This is

around £28/customer higher than its closest competitor. This gives EdF considerable scope

to price more aggressively in retail supply and gain customer market share.

Centrica, E.On Energy and SSE at competitive disadvantage. We believe Centrica could

see a decrease of £10-18/cust in its net generation and supply earnings power as a

result of the declining household energy demand and the shift in profitability from old

fossil fuel generation to clean generation. For SSE and E.On Energy the net negative

impact could be as high as £10/cust and £16/cust respectively. In practice, we would

expect them to try and raise retail tariffs to offset this, and to try and earn a return on

incremental clean generation investment. However, EdF Energy, RWE npower and

ScottishPower could all be in a position to compete more aggressively on price and try

and gain market share. Indeed, we believe EdF Energy would have the potential to

undercut Centrica’s pricing by nearly £100/cust on an average dual fuel bill.

EdF Energy and RWE npower

have the relative earnings

momentum and motivation to

grab market share




2 November 2011 21

Figure 26: Net shift in generation and supply EBITDA (£ per residential single fuelcustomer, 2012-15E)

(10 )

37

(8 )

510

(7 )

0

(18 )

31

(16 )

(2 )

3

(14 )(7 )

(30 )

(20 )

(10 )

0

10

20

30

40

50

C N A

E D F

E . O N

R WE

I B E

S S E

" B i g 6 "

A v e r a g e


EdF’s exposure to clean

generation leaves it positioned to

compete more aggressively in

the downstream retail market


We see several motivations for why EdF Energy and RWE npower in particular could start to

price more aggressively in the retail market:

Rebalancing upstream/downstream exposure. As shown in Figure 27, EdF is already

significantly long generation following its acquisition of an 80% stake in British Energy,

while RWE npower’s investment in 3.8GW of new CCGT will leave it long, even after its

opted-out coal plant closes. Both companies currently have relatively low market share

(Figure 27), and have an incentive to increase customer numbers in order to have a

more balanced upstream/downstream hedge.

Kick-starting growth. In our view, RWE’s new group CEO, Peter Terium, faces a challenge

to reposition RWE as a business with genuine growth prospects. Our analysis in this report

suggests that the UK could genuinely provide such an opportunity. More aggressive

competition for customers could allow RWE to significantly increase the scale of its UK

operations over time, though potentially at the expense of near-term profits.

Figure 27: Residential energy customers, 2010 (m) Figure 28: Upstream/downstream hedge (%)

9.3

2.1 2.9 2.6 2.03.6

6.6

3.45.0

4.03.2

5.2

0

2

4

6

8

10

12

14

16

18

CNA EDF E.ON RWE IBE SSE

Gas Electrici ty

0%

50%

100%

150%

200%

250%

300%

CNA EDF E.ON RWE IBE SSE

2010A 2016E

Source: Company reports. Source: Barclays Capital.




2 November 2011 22

Offset declining average revenues. The decline in energy demand will put pressure on

average revenue per customer for the whole industry. If political pressure makes it

difficult to compensate for this through higher retail tariffs, the alternative is to increase

customer numbers.

Cash cow to fund future investment. A large downstream customer base can be a

source of stable cash generation to help fund future investment in e.g. new nuclear,offshore wind.

There is evidence already that RWE npower and EdF Energy are competing more

aggressively on price: they were the last to raise retail tariffs in the latest round of price

increases, raised their prices by the lowest amount, and based on our estimates will have

the lowest weighted average sales price after the price increases have taken effect.

Figure 29: Big 6 UK utilities residential price increase analysis

Price Increase Weighted Average Sales Price*, 2012E

Date of

Increase Gas Electricity Gas (p/th)

Electricity

(p/kWh)

Average

(Index)

EdF Energy 10-Nov 15% 5% 112 118 100

RWE npower 01-Oct 16% 7% 116 123 104

SSE 14-Sep 18% 11% 122 123 107

E.On Energy 13-Sep 18% 11% 111 132 105

British Gas 18-Aug 18% 16% 127 131 112

ScottishPower 01-Aug 19% 10% 118 127 107

Source: Barclays Capital, company data.* Methodology: we take 2010A WASP quoted in the Ofgem Consolidated Segmental Statements and apply year-

average retail price increases to derive a 2012E WASP. It is important to note that the accuracy of this calculation isaffected by the lack of disclosure on the number of fixed-price customers and changing tariff mix (e.g. discounted

internet tariffs versus standard credit). Therefore, the analysis is for illustrative purposes only . Indeed, Ofgem iscurrently trying to address the difficulty customers face in comparing retail tariffs between companies.

Political pressure is already having an impact

Regulatory and political pressure is already prompting all six of the Big 6 utilities to change

their behaviour. The UK government has asked all of the Big 6 to offer simplified tariffs, to

make it easier for customers to switch, and to indicate to customers whether cheaper tariffs

are available. Ofgem has proposed that it will effectively re-regulate standing charges.

SSE, in particular, has been fast to respond to the political and regulatory criticism. It was the

first to end doorstep selling, suspending it in July 2011 after it was found guilty of mis-selling –

the rest of the Big 6 are now following. It has been the first to scrap discounted internet tariffs,

to respond to accusations of predatory pricing by Chris Huhne, the UK Energy Secretary 11. It

has also written to its customers and to Huhne, pledging a fairer deal for its customers.

In the very short term these measures, somewhat ironically, may reduce customer

switching (less doorstep selling) and raise weighted average sales prices (no more

discounted internet tariffs). However, over time, we believe the changes should lead to

increased customer switching and a migration to lower tariff levels. This could play into the

hands of EdF Energy and RWE npower.

11 “It is not fair that big energy companies can push their prices up for the vast majority of their consumers – who do

not switch – while introducing cut-throat offers for new customers that stop small firms entering the market … that looks to me like predatory pricing. It must and will stop” , Chris Huhne’s speech at the Liberal Democrat partyconference, 20 September 2011.

Political pressure could be a

catalyst for greater competition




2 November 2011 23

COMPANY SECTION




2 November 2011 24

COMPANY SNAPSHOT

Centrica Integrated Utilities

Income statement (£m) 2010A 2011E 2012E 2013E CAGR

EBITDA, adjusted 3,320 3,498 3,777 3,823 4.8% Stock Rating 3-UNDERWEIGHT

EBIT, adjusted 2,390 2,603 2,788 2,764 5.0% Sector View 2-NEUTRAL

Pre-tax income, adjusted 1,929 2,222 2,418 2,401 7.6% P rice (31-Oct-2011) £2.97

Net income, adjusted 1,297 1,359 1,397 1,412 2.9% Price Target £2.60

EPS, adjusted (p) 25.2 26.3 26.9 27.1 2.5% Ticker RIC: CNA.L, BB: CNA LN

Diluted shares (m) 5,191 5,213 5,234 5,256 0.4%

Dividend per share (p) 14.3 15.0 15.8 16.6 5.0% Investment case

Margin and return data (%) Average

EBITDA margin 14.0 14.7 15.0 14.6 14.6

EBIT margin 10.1 11.0 11.0 10.6 10.7

Pre-tax margin 8.1 9.4 9.6 9.2 9.1

Net margin 5.5 5.7 5.5 5.4 5.5

ROIC 12.0 10.2 10.1 9.9 10.5

ROA 8.0 7.4 7.2 7.0 7.4

ROE 25.7 22.3 21.1 19.8 22.2 Upside case £3.63

Balance sheet and cash flow (£m) CAGR

Net PP&E 6,398 6,942 7,215 7,320 4.6%

Total net assets 18,820 19,438 20,366 20,524 2.9%

Capital employed (average) 12,680 13,788 14,290 14,492 4.6%

Shareholders' equity 5,819 6,351 6,893 7,407 8.4%

Economic net debt (3,312) (3,310) (3,023) (2,618) NA

Operating cash flow 2,679 2,172 2,307 2,369 -4.0% Downside case £2.06

Capital expenditure (592) (1,298) (1,262) (1,163) NA

Free cash flow 2,087 874 1,045 1,205 -16.7%

Pre-dividend FCF 866 763 1,075 1,235 12.6%

Valuation and leverage metrics AverageP/E (x) 11.8 11.3 11.0 10.9 11.3

EV/EBITDA (x) 6.2 5.9 5.4 5.2 5.7

EV/NOPAT (x) 13.6 14.6 14.1 13.9 14.0 Upside/downside scenarios

Dividend yield (%) 4.8 5.1 5.3 5.6 5.2

FCF yield (%) 13.6 5.7 6.8 7.8 8.5

P/BV (x) 2.6 2.4 2.2 2.1 2.3

EV/IC (x) 1.5 1.5 1.4 1.4 1.4

Net debt/EBITDA (x) 1.0 0.9 0.8 0.7 0.9

Selected operating metrics

Energy hedge ratio (%) 52.2 58.8 61.1 57.0

G as product. (mm therms ) 3,199 2,984 3,076 3,111

Electricity product. (TWh) 32.9 26.7 19.7 18.1 Source: DataStream

BGRE - EBIT margin (%) 8.9 7.4 6.7 7.0 British Gas Residential EBIT Margin (%)

BGRE - Energy cust. (m) 16.0 15.9 15.6 15.4

BGRE - WACOG (p/th) 49.5 57.2 68.2 70.6

BGRE - WACOE (£/MWh) 45.1 61.1 66.3 62.7

Source: Company data, Barclays Capital Note: FY end Dec.

Why a 3-U W? We believe Centrica's competitive

advantage in the UK will fade, dr iven in pa rt by

declining gas demand. We believe weak spreads will

lead to disappointing power generation profits.

Our ups ide case ass umes s pa rk s preads rise by

£5/M Wh and retai l mar gins by 1%. We ass ume

Centrica trades in line with SOTP.

Our downside case sees Centrica's BGRE margin

squeezed by a further 1%, and assumes that

Centrica derates to 8x 2013E P/E

0

2

4

6

8

10

2010E 2011E 2012E 2013E

Downside

Case

206p

(-30.5%)

Price

Target

260p

(-12.3%)

Upside

Case

343p

(15.6%)

103

153

203

253

303

353

403

18-Nov-2010 31-Oc t-11

Downside

Case

206p

(-30.5%)Price

Target

260p

(-12.3%)

Upside

Case

363p

(22.3%)

103

203

303

403

18-Nov-2010 31-Oc t-11




2 November 2011 25

CENTRICA – NOT SO SAFE AFTER ALL

Over the past few months we have argued that Centrica is a relative safe haven. Its

defensive characteristics have been borne out in 14% outperformance relative to the

Stoxx 600 since May. Whilst its financial position remains robust, the economic and

retail market environment is evolving rapidly. In particular, with declines in energydemand accelerating, we now think both sides of Centrica’s upstream hedge could

come under pressure. We believe its competitive advantage in the UK retail market will

fade, and that persistently weak spark spreads will lead to disappointing power

generation profits in 2012/13E. We also see increasing downside risks for BGS, BGB and

Direct Energy given the deteriorating economic environment. We cut our 2012-14E EPS

forecasts to 7% below consensus on average. In the current market environment, we

doubt Centrica can trade at our revised SOTP valuation of £3.29. Given the deteriorating

fundamentals, we believe Centrica’s shares could instead derate towards their historical

P/E discount to the Stoxx Utilities index of -0.5, implying 12% share price downside. We

downgrade Centrica from 1-OW to 3-UW with a new £2.60 price target.

Power generation squeeze 2011-13E

Clean spark spreads in the UK have been steadily declining since the start of 2010. The

winter 2012/13 spread is currently trading at just £1.0/MWh. Unfortunately for Centrica,

which currently has economic interests in 5.1GW of installed CCGT capacity in the UK, we

would not expect these to recover before 2014, based on current relative gas and coal

prices. Because of these weak spreads, we expect load factors for older, unhedged CCGT

plant to collapse to below 10% over 2012-15E. We only expect these to pick up as coal

plant gets pushed to the margin, by around 2016. Figure 30 summarises our spark spread

and load factor forecasts.

Figure 30: UK power price, clean spark spread (CSS) and CCGT load factor forecasts (£/MWh, net of carbon price floor)

2011E 2012E 2013E 2014E 2015E 2016E

Baseload Power – BarCap Forecast 51.5 52.4 54.6 61.1 64.7 67.8

Baseload Power – Forward Curve* 51.4 53.7 54.7 - - -



CCGT Load Factor - 49% Efficiency 10% 7% 8% 5% 18% 26%

CCGT Load Factor - 58-59% Efficiency 43% 37% 77% 76% 74% 74%

Source: Barclays Capital, Bloomberg. * Forward curve as at 21 October 2011.

As a result, we believe Centrica’s CCGT fleet will not cover its fixed costs over the next 2-3

years. We expect Centrica to respond by closing some of its least profitable CCGT assets.Indeed, Centrica has already been reported to be planning closing 570MW of CCGT capacity

in 2012 (Barry and Kings Lynn)12. Centrica may also be able to recover some fixed costs by

providing ancillary services to National Grid.

Centrica’s exposure to clean generation via its wind capacity, its 20% stake in British Energy

and its new CCGT capacity should help drive a generation margin recovery over the

medium-term, but we do not expect any material impact before 2013/14, when the UK

carbon price floor kicks in.

12 “Centrica job and plant cuts could spark price increases” , The Times, 17 October 2011.

CNA.L / CNA LN

Stock Rating

3-Underweight

Sector View

2-Neutral

Price Target

£2.60

Price (31 Oct 2011)

£2.97

Potential Upside / Downside

-12.4%

Our power generation EBIT

forecasts are up to 60% below

consensus




2 November 2011 26

Overall, our forecasts for Centrica’s UK power generation division for 2012-13E are

materially below consensus, as shown in Figure 31. Our forecasts assume British Energy

delivers 53TWh of output, in line with historic average but below our 2011E forecast of

57TWh. Each +1TWh would add +£9m of EBIT.

Figure 31: Centrica’s UK Power Generation EBIT (£m)

2011E 2012E 2013E

BarCap 252 211 150

Consensus 279 332 372

Difference -10% -36% -60%

Source: Barclays Capital, company data.

Greater exposure to falling energy demand

Underlying UK residential gas demand was down around 5.8% in 1H11, double the rate of

decline of electricity demand. Our analysis in this report concludes that if improvements in

household energy efficiency continue in line with the trend over the past five years, and our

economists are correct about real income growth, we would expect household gas andelectricity consumption to continue to decline by around 2.1% and 0.7% per annum

respectively. However, if there was little or no growth in real income, we would expect the

declines to be 3.7% and 2.4% per annum respectively.

We expect Centrica to be more negatively impacted than its competitors given its high

volume share of the residential gas market. Indeed, under our fast demand decline scenario,

we estimate Centrica could see a demand decline that amounts to a loss of EBIT margin of

£17/cust over 2012-15E – nearly half of its 2011E margin of £38/customer.

Increasing downstream competition

Based on our analysis in this report, we conclude that EdF Energy and, to a lesser extent,

RWE npower have both the earnings momentum and the motivation to drive a more

aggressive pricing strategy in the downstream residential energy market. Specifically we

estimate that over 2012-15E EdF Energy could see a positive underlying delta in its UK

generation and supply EBITDA of £31-37/cust, compared to a £10-18/cust delta for

Centrica. This amounts to a net delta in profitability between the two companies of £100

per dual fuel customer.

We believe this could serve to reduce Centrica’s retail pricing power over the next 2-3 years,

and potentially put pressure on Centrica’s BGRE EBIT margin. We estimate EdF Energy’s

weighted average sales price (i.e. across all gas/electricity products) is already below that of

Centrica, following recent tariff increases (see Figure 29), and EdF’s superior profit

momentum could allow it to further widen the gap.

Centrica’s management is unlikely to take this lying down. It could respond by pricing more

aggressively to maintain market share, though this would put significant pressure on its

BGRE EBIT margin; or it could seek to preserve margins, though this could put Centrica back

into a similar position to the one it found itself in 2004-2006 when SSE competed

aggressively on price and Centrica lost 2.7m customers.

Gas demand could fall by a

further 4% pa in 2012/13E

EdF Energy represents a growing

competitive threat




2 November 2011 27

Earnings outlook deteriorating

We have cut our EPS forecasts to 7% below consensus on average, to reflect the risks we

have identified in this report. Specifically, we have made the following key changes to

forecasts:

British Gas Residential Energy. We factor in our weaker energy demand assumptions,

and assume Centrica picks a middle road between managing market share and margin.

We assume no tariff increase for 2012E, but assume tariffs rise by 15% 2012-15E to

recover some of the cost pressures faced by the industry (though we assume no further

increase in forward wholesale gas prices). We assume 200k net customer losses per

annum to 2015E, equivalent to 0.5% annual market share loss, and that EBIT falls

Centrica’s target level of c£600m in 2011-13E (6.7-7.0%) to c£500m by 2015E (5.7%

margin). Our forecasts assume management take action to reduce operating costs

further (by £30m), and that churn is lower than in the past due to increased penetration

of multi-product customers. While Centrica’s management consider this to be a key

advantage compared to the competition, we believe Centrica will struggle to fully offset

top-line pressures.

British Gas Business and Services. In line with Centrica’s own expectations, we expectrevenue investment to keep EBIT relatively flat in BGB over 2011-13E. We also believe

the scope for longer-term margin expansion will be limited by increasing competition in

the commercial energy market. Centrica is targeting double-digit EBIT growth for BGS,

mainly driven by cost-control rather than top line growth. However, given the

increasingly challenging economic environment, we reduce our 2011-14E forecast from

9.4% to 7.6% EBIT CAGR. We recognise that suspension of marketing activity at a key

competitor, Homeserve, could provide short-term upside to product sales. Separately,

we also believe a challenging economic environment could constrain growth in

Centrica’s North American home services and business supply divisions.

Upstream energy. We mark-to-market our commodity price assumptions13, reflecting

the current contango in the forward gas curve. The current backwardation in theforward curve for Brent crude brings down our forecasts for Upstream Gas and Oil,

which produces 11-12mmboe of liquids per annum. As described above, we are now

more bearish on the outlook for Centrica’s power generation division.

Figure 32: Centrica – EPS revisions (p)

2011E 2012E 2013E 2014E

BarCap EPS - New 26.3 26.9 27.1 28.9

BarCap EPS - Old 26.7 30.7 32.5 35.2

Change -1.7% -12.2% -16.6% -17.8%

Consensus EPS 26.0 28.3 30.7 30.3Difference 1.2% -4.9% -11.6% -4.7%

Source: Barclays Capital, DataStream.

We note that Centrica’s robust cash flow and balance sheet mean that it is progressively

deleveraging. That gives management financial flexibility to enhance EPS through either

acquisitions or share buybacks – an upside risk to our forecasts. We believe Centrica’s

management is comfortable with net debt/EBITDA around 1.0x, suggesting c£1bn of balance

sheet capacity by 2013. We estimate that this would enhance EPS by c5%, or 1.3p/share.

13 As at 21 October 2011.

We cut EPS forecasts to 7%

below consensus on average

Balance sheet re-leverage is a

modest upside risk to earnings




2 November 2011 28

P/E analysis justifies a £2.60 price target

Our analysis leads us to cut our SOTP valuation from £3.72 to £3.29, principally reflecting a

lower long-term BGRE margin assumption (reduced from 5.5% to 5.0%) and the impact of

lower commodity prices and spreads for Centrica’s upstream activities.

Our SOTP valuation points to modest upside for Centrica. However, we have to accept the fact

that Centrica has rarely traded close to SOTP. For example, over the past two years Centrica

has consistently traded at a 10% discount to its Bloomberg consensus average target price.

Given the negative earnings momentum we now expect for Centrica, we believe P/E may be

a better indicator of where Centrica’s shares could trade on a 12-month view. Figure 33

shows that, over the past five years, Centrica has on average traded at a -0.5 point Y+2 P/E

discount to the Stoxx Utilities index, with a standard deviation of -1.9 to +0.8.

Based on current consensus 2013E EPS, Centrica is trading at 9.7x 2013E P/E, compared to

an average Y+2 P/E for the Stoxx Utilities index of 10.0x this year (current Y+2 P/E is 9.9x).

Give the deteriorating fundamentals, we believe Centrica should de-rate to at least its

historical average discount of -0.5x, implying a target 2013E P/E of 9.5x. When coupled

with our 2013E EPS forecast of 27.1p (12% below consensus), this implies a target price of £2.60 – a 20% discount to our SOTP valuation.

Given our view of the challenges that Centrica is likely to face in the UK, such a discount

may well be warranted. Investors may take a more critical view of the assumptions used to

drive the SOTP. Our SOTP is based on a series of DCF models, and uses a 7.7% post-tax

nominal discount rate and a series of long-term margin assumptions for its downstream

activities. A £2.60 price target would be consistent with a 1ppt reduction in long-term

margin assumptions, and a 1ppt increase in our WACC.

We note a flaw in this approach, which is that Centrica’s robust cash flow and balance sheet

mean that it is progressively deleveraging. That gives management financial flexibility to enhance

EPS through either acquisitions or share buybacks. We believe Centrica’s management is

comfortable with net debt/EBITDA around 1.0x, suggesting c£1bn of balance sheet capacity by

2013. We estimate that this would enhance EPS by around 5%, or 1.3p/share.

Figure 33: Centrica – average forward P/E premium/discount vs. Stoxx Utilities

-4.0x

-3.0x

-2.0x

-1.0x

0.0x

1.0x

2.0x

3.0x

4.0x

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Y+1 Y+2

Centrica has on average traded

at a 0.5 point P/E discount to

European Utilities

Source: Bloomberg, Barclays Capital.

Centrica does not appear to

trade on SOTP…

…we think P/E is a better

indicator of share price

performance

Deteriorating fundamentals

justify a derating

Balance sheet re-leverage is a

modest upside risk to earnings




2 November 2011 29

Figure 34: Centrica – SOTP valuation (as at 31 December 2012)

£m p/share %EV

EB/EBITDA

2011E

EB/EBITDA

2012E

CAGR

11-15E

British Gas Residential 4,617 89 21.0% 6.9x 7.1x -3.6%

British Gas Business 2,522 49 11.5% 9.6x 9.3x 3.7%

British Gas Services 2,870 55 13.1% 10.5x 9.7x 6.9%

Gas Production and Development 4,474 86 20.4% 3.3x 2.7x 5.8%

Power Generation - Conventional 1,173 23 5.3% 3.2x 3.4x 4.4%

Power Generation - 20% British Energy 2,170 42 9.9% - - -

Industrial and Commercial 12 0 0.1% - 6.0x -

Accord Energy Trading 115 2 0.5% - 6.0x -

Centrica Storage 815 16 3.7% 8.5x 11.2x 5.6%

Direct Energy 3,170 61 14.4% 8.0x 7.1x 7.2%

Enterprise Value 21,937 422 - 6.3x 5.8x 4.0%

Net Debt (3,023 ) (58 )Net Pension Deficit (72 ) (1 )

Provisions (1,746 ) (34 )

Minorities 0 0

Equity Value 17,097 329





2 November 2011 30

Figure 35: Centrica – Financial ratios and valuation multiples

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

EPS/DPS

EPS - Recurrent (p/share) 21.7 21.7 25.2 26.3 26.9 27.1 28.9 29.9

DPS - Total (p/share) 12.2 12.8 14.3 15.0 15.8 16.6 17.4 18.3

Valuation Multiples

P/E (x) - - - 11.3x 11.0x 10.9x 10.3x 9.9x

EV/EBITDA (x) - - - 5.9x 5.4x 5.2x 5.0x 4.8x

EV/EBITDA - Ex-Upstream Gas (x) - - - 7.7x 7.6x 7.3x 7.1x 6.9x

EV/NOPAT (x) - - - 14.6x 14.1x 13.9x 13.1x 12.5x

Dividend Yield (%) - - - 5.1% 5.3% 5.6% 5.9% 6.2%

FCF Yield (%) - - - 5.7% 6.8% 7.8% 6.7% 7.8%

P/BV (x) - - - 2.4x 2.2x 2.1x 1.9x 1.8x

EV/IC (x) - - - 1.5x 1.4x 1.4x 1.3x 1.3x

Financial Ratios

Dividend Payout Ratio (%) 56.2% 59.0% 56.7% 57.1% 58.6% 61.1% 60.1% 61.1%

Financial Net Debt/EBITDA (x) 0.2x 1.2x 1.0x 0.9x 0.8x 0.7x 0.6x 0.5x

ROE 23.5% 25.8% 25.7% 22.3% 21.1% 19.8% 19.7% 19.0%

ROIC 14.0% 12.5% 12.0% 10.2% 10.1% 9.9% 10.3% 10.4%

WACC - - - 7.7% 7.7% 7.7% 7.7% 7.7%

Weighted Ave. Shares (mm) 4,198 5,121 5,146 5,168 5,189 5,211 5,232 5,253

Source: Barclays Capital, DataStream.

Figure 36: Centrica – Segmental operating profit (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Residential Energy Supply 376 598 742 605 579 609 547 507

Business Energy Supply and Services 143 183 233 247 252 263 272 283

Residential Services 193 230 241 262 285 309 324 339

Upstream Gas and Oil 1,164 444 581 855 1,049 1,002 977 969

Power Generation 11 147 226 252 211 150 238 283

Industrial and Commercial (331 ) (93 ) (36 ) 0 1 2 2 2

Proprietary Energy Trading 37 27 0 19 19 19 19 19

Storage UK 195 168 169 70 45 33 66 84

North America 215 153 234 293 345 379 404 421

Other 0 0 0 0 0 0 0 0

Adjusted Operating Profit 2,003 1,857 2,390 2,603 2,788 2,764 2,849 2,907

Growth (%) 2.8% -7.3% 28.7% 8.9% 7.1% -0.8% 3.1% 2.1%

Margin (%) 8.5% 7.9% 10.1% 11.0% 11.0% 10.6% 10.4% 10.2%





2 November 2011 31

Figure 37: Centrica – Income statement (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

External Revenue 20,872 21,963 22,423 22,357 23,806 24,704 25,762 26,725

Costs (18,251 ) (19,410 ) (19,246 ) (19,139 ) (20,276 ) (21,154 ) (22,142 ) (22,992 )

Income from Associates 12 28 143 280 247 272 337 367EBITDA 2,633 2,581 3,320 3,498 3,777 3,823 3,957 4,100

Depreciation and Amortisation (630 ) (724 ) (930 ) (895 ) (989 ) (1,058 ) (1,108 ) (1,193 )


JV/Associate Interest/Tax (3 ) (11 ) (78 ) (77 ) (65 ) (68 ) (81 ) (87 )

Fair Value Adjustments (8 ) (32 ) (118 ) (120 ) (120 ) (120 ) (120 ) (120 )

Operating Profit 1,992 1,814 2,194 2,407 2,603 2,576 2,648 2,700

Net Interest (45 ) (227 ) (275 ) (195 ) (195 ) (185 ) (167 ) (155 )

Other Finance Income/(Costs) 43 48 10 10 10 10 10 10

PBT 1,990 1,635 1,929 2,222 2,418 2,401 2,491 2,555

Tax (1,026 ) (531 ) (708 ) (960 ) (1,118 ) (1,086 ) (1,076 ) (1,082 )

Effective Tax Rate (%) 51.6% 32.5% 36.7% 43.2% 46.2% 45.2% 43.2% 42.3%

Income from Discontinued Operations (52 ) 40 (5 ) 0 0 0 0 0

Minority Interests (1 ) (50 ) (7 ) 0 0 0 0 0

Fair Value Adjustments - 17 88 97 97 97 97 97

Adjusted Net Income 911 1,111 1,297 1,359 1,397 1,412 1,512 1,570

Growth (%) -18.8% 22.0% 16.7% 4.8% 2.8% 1.1% 7.1% 3.9%

Margin (%) 3.9% 4.7% 5.5% 5.7% 5.5% 5.4% 5.5% 5.5%

Continuing EPS - Basic (p) 1.1 12.7 36.4 24.4 25.1 25.2 27.0 28.0

Continuing EPS - Adjusted (p) 21.7 21.7 25.2 26.3 26.9 27.1 28.9 29.9

Growth (%) -20.1% 0.0% 16.1% 4.3% 2.4% 0.6% 6.6% 3.4%

DPS - Interim (p) 3.5 3.7 3.8 4.3 4.5 4.7 5.0 5.2

DPS - Final (p) 8.7 9.1 10.5 10.7 11.3 11.8 12.4 13.0

DPS - Total (p) 12.2 12.8 14.3 15.0 15.8 16.6 17.4 18.3

Growth - Ordinary DPS (%) 5.4% 4.9% 11.7% 5.0% 5.0% 5.0% 5.0% 5.0%

Payout Ratio (%) 56.2% 59.0% 56.7% 57.1% 58.6% 61.1% 60.1% 61.1%





2 November 2011 32

Figure 38: Centrica – Cash flow (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Operating Profit 652 1,174 3,081 2,275 2,493 2,445 2,464 2,492

+ Depreciation, Amortisation and Impairment 630 917 1,153 895 989 1,058 1,108 1,193

+/- Changes in Provisions (106 ) 11 (105 ) (100 ) 0 0 0 0+/- Change in Working Capital (1,083 ) 899 435 (175 ) (68 ) (8 ) (25 ) (31 )

+/- Other Non-Cash Items 1,111 (12 ) (1,339 ) 0 0 0 0 0

+ Dividends from Associates 0 0 0 173 146 164 209 229

- Net Interest (24 ) 10 (6 ) (195 ) (195 ) (185 ) (167 ) (155 )

- Income Tax (907 ) (503 ) (540 ) (702 ) (1,058 ) (1,106 ) (1,078 ) (1,078 )

Operating Cash Flow 273 2,496 2,679 2,172 2,307 2,369 2,511 2,650

- Capital Expenditure (546 ) (2,964 ) (592 ) (1,298 ) (1,262 ) (1,163 ) (1,473 ) (1,437 )

Free Cash Flow (273 ) (468 ) 2,087 874 1,045 1,205 1,037 1,213

+/- Acquisitions and Disposals (552 ) (1,244 ) (1,243 ) (141 ) 0 0 0 0

+/- Change in Equity 2,199 25 22 30 30 30 30 30

- Dividends Paid to Shareholders/Minorities (500 ) (635 ) (668 ) (760 ) (788 ) (831 ) (876 ) (924 )

Net Cash Flow 874 (2,322 ) 198 2 287 404 191 319

Other Movements in Net Debt (590 ) (303 ) (374 ) 0 0 0 0 0

Non-Recourse Financial Net Cash/(Debt) (511 ) (3,136 ) (3,312 ) (3,310 ) (3,023 ) (2,618 ) (2,427 ) (2,108 )

Net Debt/EBITDA 0.2x 1.2x 1.0x 0.9x 0.8x 0.7x 0.6x 0.5x


Figure 39: Centrica – Balance sheet (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Tangible Fixed Assets 4,689 6,059 6,398 6,942 7,215 7,320 7,686 7,930

Intangible Assets 2,181 2,822 3,454 3,454 3,454 3,454 3,454 3,454

Investments 330 2,422 2,507 2,465 2,430 2,397 2,372 2,351

Cash/Marketable Securities 3,002 1,368 490 635 553 475 503 595

Working Capital Assets 5,786 4,632 4,612 4,582 4,877 5,063 5,281 5,478

Other Assets 2,478 1,661 1,359 1,359 1,837 1,814 1,814 1,814

Total Assets 18,466 18,964 18,820 19,438 20,366 20,524 21,109 21,622

Short-Term Debt (330 ) (86 ) (77 ) (77 ) (77 ) (77 ) (77 ) (77 )

Long-Term Debt (3,218 ) (4,594 ) (3,959 ) (4,102 ) (3,733 ) (3,250 ) (3,087 ) (2,860 )

Working Capital Liabilities (4,395 ) (3,955 ) (4,059 ) (3,844 ) (4,061 ) (4,229 ) (4,411 ) (4,568 )

Provisions (1,080 ) (2,007 ) (1,985 ) (1,885 ) (1,885 ) (1,885 ) (1,885 ) (1,885 )

Other Liabilities (5,071 ) (4,545 ) (3,376 ) (3,635 ) (3,695 ) (3,676 ) (3,673 ) (3,677 )

Total Liabilities (14,094 ) (15,187 ) (13,456 ) (13,543 ) (13,451 ) (13,117 ) (13,134 ) (13,067 )

Shareholders' Equity 4,312 4,192 5,819 6,351 6,893 7,407 7,975 8,555

Minority Interest/Other 60 63 0 0 0 0 0 0

Total Equity 4,372 4,255 5,819 6,351 6,893 7,407 7,975 8,555





2 November 2011 33

This page is intentionally left blank




2 November 2011 34

COMPANY SNAPSHOT

Drax Generators


EBITDA, adjusted 391 321 331 200 -20.0% Stock Rating 1-OVERWEIGHT

EBIT, adjusted 338 264 273 134 -26.5% Sector View 2-NEUTRAL

Pre-tax income, adjusted 315 240 260 116 -28.4% Price (31-Oct-2011) £5.43

Net income, adjusted 233 189 199 94 -26.1% Price Target £6.75

EPS, adjusted (p) 63.8 51.8 51.1 22.6 -29.2% Ticker RIC: DRX.L, BB: DRX LN

Diluted shares (m) 366 366 391 416 4.4%

Dividend per share (p) 32.0 25.9 25.6 11.3 -29.3% Investment case


EBITDA margin 23.7 17.2 17.6 10.1 17.1

EBIT margin 20.5 14.2 14.5 6.8 14.0

Pre-tax margin 19.1 12.9 13.8 5.8 12.9

Net margin 14.1 10.2 10.6 4.7 9.9

ROIC 19.5 18.2 17.5 7.0 15.6

ROA 11.6 9.7 9.0 3.8 8.5

ROE 23.5 17.3 14.1 5.8 15.2 Upside case £15.52

Balance sheet and cash flow (€m) CAGR

Net PP&E 1,184 1,167 1,291 1,461 7.3%

Total net assets 2,047 1,976 2,558 2,771 10.6%

Capital employed 1,043 1,086 1,241 1,659 16.7%

Shareholders' equity 958 1,224 1,605 1,615 19.0%

Adjusted net debt 204 210 422 3 -76.5%

Cash flow from operations 411 169 216 (97) NA Downside case £3.30

Capital expenditure (62) (40) (182) (236) NA

Free cash flow 349 129 34 (333) NA

Pre-dividend FCF 349 129 284 (333) NA


EV/EBITDA (x) 4.4 5.4 5.4 11.1 6.6


Dividend Yield (%) 5.9 4.8 4.7 2.1 4.4

FCF Yield (%) 17.6 6.5 1.5 - 14.8 2.7

P/BV (x) 2.1 1.6 1.4 1.4 1.6

EV/IC (x) 1.7 1.6 1.4 1.3 1.5

Net debt/EBITDA (x) (0.5) (0.7) (1.3) (0.0) - 0.6


Payout ratio (%) 50.1 50.0 50.0 50.0

Power price (£/MWh) - 55.6 55.8 57.0

Dark spread (£/MWh) - 16.8 18.3 16.2 Source: Thomson Reuters Datastream, Barclays Capital est.

Load factor (%) 79.7 80.0 80.0 80.0 Output (TWh)

Output (TWh) 26.4 26.5 26.6 26.5

Source: Company data, Barclays Capital Note: FY end Dec.

Why a 1-OW? We now believe it is highly likely that

D rax wi ll pr oceed with pla ns to convert to 50%

biomass co-firing. This completely transforms the

equity story of Drax, securing its position in the UK

power market for the long-term. Drax also retains

the option to convet to 100% in the future.

Our upside scenario assumes Drax invests further

(we assume £250m) to fully-covert the plant into

dedicated biomass by 2020 at 1.0x ROC.

Our downside case assumes 50% conversion, but

thermal efficiency of 35%, high capex and a 10%

rise in coal prices.

24.0

25.0

26.0

27.0

28.0

2010A 2011E 2012E 2013E

Output (TWh)

28

48

68

88

108

18-Nov-10 31-Oct-11

Downside

Case

330p

(-39.2%) Price

Target

675p

(24.3%) Upside

Case

1552p

(185.%)

165

665

1165

1665

18-Nov-10 31-Oct-11




2 November 2011 35

DRAX – FROM DARK TO BARK

Following the proposed increase in ROC support, we now believe it is highly likely that

Drax will proceed with plans to convert to 50% biomass co-firing. We believe this

completely transforms the equity story of Drax, securing its position in the UK power

market for the long-term. A combination of the carbon tax and ROC support shouldunderpin progressively rising earnings. Over the medium term our analysis suggests

that Drax has the potential to return significant amounts of cash to investors. Numerous

uncertainties remain, meaning we believe Drax remains a risky stock. Nonetheless, we

see the upside potential as potentially very high indeed, particularly if Drax opts to

convert the plant to 100% biomass in the future. We upgrade from 3-UW to 1-OW and

set a new price target of £6.75.

Biomass conversion transforms earnings outlook

The key driver for Drax’s shares up until now has been the UK “clean dark spread”.

However, if, as we expect, Drax converts to 50% biomass co-firing, this will change. The key

driver of Drax’s EBITDA will instead become the “bark spread” – the gross margin on co-firing biomass. Given the significant pressure we see on dark spreads over the next few

years, this is a transformational story for Drax.

This bark spread has three components: the power price, the ROC price and the cost of

biomass. We think its characteristics will be rather more attractive than that of the clean

dark spread:

Carbon price floor drives progressive growth in power prices. We expect the carbon

price floor to underpin a 30% increase in UK power prices to 2020 (relative to current

EUA futures). Our modelling shows that the pass-through of the carbon tax into

wholesale power prices should step up in 2017E as conventional hard coal plant moves

to the margin in the UK, substantially improving the economics of biomass.

Figure 40: Impact of carbon price floor on UK power prices (£/MWh)

2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Baseload Power – with carbon floor 51.5 52.4 54.6 61.1 64.7 67.8 71.2 73.1 74.7 76.6

Baseload Power – no carbon floor 51.5 52.4 52.4 54.2 54.9 56.9 58.0 59.2 60.5 62.0

Difference - - 2.1 6.8 9.7 10.9 13.1 13.9 14.2 14.6


ROC prices supported by buy-out price. Our analysis suggests that growth in UK

renewables (including Drax’s own plans) will put downward pressure on ROC prices

(currently trading at £45). However, the buy-out price should provide support at a level

of at least £40 (see Figure 23).

Implicit inflation protection. Both the carbon price floor and the ROC buy-out price are

linked to UK RPI, giving revenues implicit inflation protection.

Long-term contracts for biomass. We expect Drax to secure a meaningful proportion of

its biomass under long-term fixed priced indexed contracts, giving a much higher

degree of cost visibility than with its current exposure to coal.

DRX.L / DRX LN

Stock Rating

1-Overweight

Sector View

2-Neutral

Price Target

£6.75

Price (31Oct 2011)

£5.43


24.3%

The “bark spread” transforms

Drax’s equity story




2 November 2011 36

As shown in Figure 41, the difference in EBITDA between Drax operating as a normal coal

plant and operating as a biomass plant is profound, though we would expect EBITDA to

start to come under pressure again as coal becomes less economic as a fuel, reducing

Drax’s load factor.

Importantly, we believe Drax will retain the option of converting to 100%, given how the

economics could transform in the latter part of the decade. This could turn Drax into a £1bnEBITDA generating asset. However, this decision would depend on the “bankability” of the

carbon price floor – which currently remains a discretionary tool for the government – or on

the attractiveness of proposed contract-for-difference feed-in tariffs.

Figure 41: Drax – from “dark spread” to “bark spread”

2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Clean Dark Spread @ 40% Efficiency (£/MWh) 18.1 15.8 15.9 15.3 14.8 14.3 12.2 9.6 7.1

Bark Spread @ 37.5% Efficiency (£/MWh)* 35.1 35.6 38.2 40.1 42.5 45.1 46.2 47.0 48.1

EBITDA - Normal Coal Operation (£m)** 343 179 206 187 147 133 106 41 (33 )

EBITDA - 50% Co-Firing by 2015 (£m) 331 200 352 427 452 460 437 376 302

EBITDA - 100% Biomass by 2020 (£m) 331 200 352 427 452 567 736 925 1,082

Source: Barclays Capital.* Our EBITDA forecasts assume Drax outperforms this by operating flexibly and by burning up to c10% energy crop biomass at 1.5x ROC.

** Assumes Drax operates as it does today, with up to 12.5% co-firing capability at 0.5x ROC.

Numerous uncertain variables remain

There are still several uncertainties relating to Drax’s plans to convert to enhance co-firing:

ROC banding. DECC has proposed an increase in the banding for enhanced co-firing

from 0.5 to 1.0x14, commencing on 1 April 2013 and grandfathered until 2027 for Drax.

The consultation will run until 12 January 2012, and DECC is expected to announce its

final decision on bandings around March 2012 (this then has to be passed intolegislation). There is a risk that the banding could be reduced, though we would ascribe

a low probability to this, given the implicit support that DECC has provided biomass in

its recent publications. Drax is currently lobbying for a further increase in the banding to

enable it to increase co-firing above 50% in the long-term, so there is also a chance that

the banding could be increased.

Capital investment. Drax is currently indicating that capex will be between £350-500m

for co-firing conversion depending on whether or not boiler modification will be

required in order to increase co-firing to 50%. Drax is likely to also have to invest in

Selective Catalytic Reduction technology on 2-3 of its units over 2013-2015 to comply

with the Industrial Emissions Directive, at an expected cost of £170-250m. For the

purposes of modelling we have taken the mid-point of both of these capex ranges.

Capital structure. We estimate that in order to convert to biomass, Drax will need to

finance around £250m of biomass stock and £350m of ROC inventory build-up over the

course of 2012-14E, in addition to the investment outlay. This implies a total capital

requirement of £950-£1,100m. Drax has indicated it may need to issue equity to finance

a portion of this, and we prudently assume a £250m capital raising in our forecasts to

keep net debt/EBITDA below 1.0x. This dilutes EPS by c10%.

14 Consultation on proposals for the levels of banded support under the Renewables Obligation for the period 2013-17 and the Renewables Obligation Order 2012, DECC, 20 October 2011.

Drax remains a risky stock




2 November 2011 37

Thermal efficiency. Co-firing is expected to reduce thermal efficiency. Until Drax has

completed the technical analysis, there is no guidance available on the potential impact.

We have assumed a 2.5% reduction in efficiency, to 37.5%. However, it is important to

note that fuel costs, and therefore Drax’s DCF valuation, are very sensitive to this number.

Biomass availability and price. Drax is likely to import the vast majority of its biomass

from accredited sustainable sources, and is seeking to strike long-term fixed-pricecontracts with suppliers. However, there is considerable variability in the price, quality

and availability of biomass.

Drax currently indicates that it is able to source biomass at between 2.0-2.5x the cost of

coal. This implies a fuel cost of in the range of £6.1-7.7/GJ. The current forward wood

pellet price (ENDEX) is in the middle of this range at £6.9/GJ. We use this as the basis of

our modelling. In reality, the range of prices for different types of biomass is very wide.Processed wood pellets typically mark the upper end of the range. Agricultural residues,

for example, are available at £0.5-4.5/GJ. We would expect Drax to be able to achieve

better than average prices given its ability to bulk purchase through long-term fixed

price contracts, and to use less processed feedstock. However, one key uncertainty that

Drax is likely to face is currency risk.

We do not see any material constraints to biomass availability per se, though

bottlenecks in the supply chain will need to be addressed. We estimate that Drax itself –

at 50% co-firing – will consume around 125PJ per annum, and that total UK biomass

generation by 2015 could be c300PJ. This is comfortably below ranges of available

biomass estimated in a report commissioned by DECC15, which suggests that by 2015

there could be 390-670PJ of domestically produced biomass available within the UK at£4/GJ (2010 prices) and a further 403-549PJ of imported biomass. The amount within

these ranges depends on the extent to which constraints are overcome (e.g. processing

plant capacity, transport infrastructure, policy uncertainty). In its recent Renewables

Roadmap16, the DECC appears committed to addressing such constraints.

15 UK and Global Bioenergy Resource – Final Report , AEA, March 201116 UK Renewable Energy Roadmap, DECC, July 2011

Figure 42: Forward wood pellet prices, CIF (£/GJ) Figure 43: Ratio of wood pellet to API2 coal

5.5

6.0

6.5

7.0

7.5

8.0

Nov-08 May-09 Nov-09 May-10 Nov-10 May-11

2010 2011 2012 2013

2.0

2.5

3.0

3.5

4.0


Source: ENDEX, Barclays Capital. Source: ENDEX, Bloomberg, Barclays Capital.




2 November 2011 38

Valuation analysis

The high probability that Drax will now pursue biomass conversion transforms the equity

story for Drax. It is no longer a binary call on UK government policy. Our revised 1-OW

recommendation reflects the significant option value that we believe a biomass conversion

strategy creates for Drax. Drax remains a risky stock, in our view, but we estimate the

upside potential under certain scenarios is considerable. We believe the reward is nowworth the risk.

We analyse risk/reward using a DCF scenario analysis. Given Drax is a finite life asset, we

believe DCF is the most appropriate valuation methodology. Our base case DCF valuation is

£5.86. However, this is very sensitive to a number of variables, as shown in Figure 44.

Figure 44: DCF valuation sensitivity and scenario analysis (£/share)

Normal Coal

Operation

50% Co-

Firing by

2015

100%

Biomass by

2020

Base Case DCF Valuation 2.16 5.86 15.52

Equity IRR (based on £5.43 share price) - 7.9% 15.8%

Sensitivities

Power Price +/- 5% 47% 34% 15%

ROC Banding +/- 0.1x 4% 15% 12%

Biomass Price +/- 5% 5% 17% 13%

Coal Price +/- 5% 19% 9% 1%

Thermal Efficiency +/- 1% 2% 9% 7%

Capex +/- £115m 4% 4% 2%

WACC* +/- 50bps 1% 7% 9%

ScenariosLow Case - 35% Efficiency / High Capex / Coal Price +10% 1.15 3.30 12.14

High Case - 38% Efficiency / Low Capex / 1.1x ROC 2.26 7.23 18.08

Source: Barclays Capital.NB. Our base case WACC assumption is 7.62% post-tax real. We assume ROC support is maintained at 1.0x after

2027, however we also assume that the UK carbon price floor remains at £30/t (it is currently stipulated to rise to£70/t by 2030).

Our scenario analysis considers three high level cases:

Normal coal plant operation. This scenario assumes that DECC reneges on its proposal

to raise the banding for enhanced co-firing from 0.5x. This would leave Drax operating

as an increasingly marginalised coal plant, worth less than half of its current share price.

We believe the probability of this scenario is less than 5%.

50% co-firing. Our base case assumes that Drax invests to progressively raise biomass

co-firing to 50% by 2015, at 1.0x ROC. We ascribe an 80% likelihood to this scenario,

which would give investors in Drax today an attractive 7.9% equity IRR.

100% biomass. This scenario assumes Drax invests further (we assume £250m) to fully-

covert the plant into dedicated biomass by 2020 at 1.0x ROC. The potential value upside

here is considerable: £15.52 under our base case power price assumptions, providing

investors with 15.8% equity IRR. We would ascribe a 15% probability to this scenario.

Drax has considerable

option value




2 November 2011 39

We then consider two alternative sets of operational assumptions:

Low case. This assumes thermal efficiency drops to 35% on co-firing, capex is towards

the top end of the range indicated by Drax (i.e. £750m for 50% conversion and SCR

retrofit), and clean dark spreads get squeezed by a 10% raise in coal prices.

High case. This assumes thermal efficiency is only modestly impacted by co-firing,capex is towards the bottom end of the range indicated by Drax (i.e. c£520m for 50%

conversion and SCR retrofit), and that DECC raises the ROC banding to 1.1x for

enhanced co-firing/ biomass conversion.

We set our price target at £6.75 based on a probability-weighted assessment of these

scenarios. Essentially, we are valuing Drax at £5.86 plus an £0.89, or 15% premium, to

reflect the option value of 100% biomass conversion. This implies 24% upside to the

current share price.

Figure 45: Drax – Financial ratios and valuation multiples

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

EPS/DPS


DPS - Total (p/share) 53.0 13.7 32.0 25.9 25.6 11.3 23.1 28.0

Valuation Multiples

P/E (x) 10.5x 10.6x 24.0x 11.7x 9.7x

EV/EBITDA (x) 5.4x 5.4x 11.1x 7.3x 5.8x

EV/NOPAT (x) 8.9x 8.8x 21.8x 12.0x 9.3x

Dividend Yield (%) 4.8% 4.7% 2.1% 4.3% 5.2%

FCF Yield (%) 6.5% 1.5% -14.8% -11.8% 8.8%

P/BV (x) 1.6x 1.4x 1.4x 1.3x 1.2xEV/Capital Employed (x) 1.6x 1.4x 1.3x 1.2x 1.2x

Financial Ratios


Financial Net Debt/EBITDA (x) 0.5x 0.2x (0.5x) (0.7x) (1.3x) (0.0x) 0.9x 0.5x

ROE 55.5% 23.8% 23.5% 17.3% 14.1% 5.8% 11.4% 12.8%

ROIC 25.3% 15.8% 19.5% 18.2% 17.5% 7.0% 11.4% 12.5%

WACC - - - 7.6% 7.6% 7.6% 7.6% 7.6%





2 November 2011 40

Figure 46: Drax – EBITDA drivers (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Clean Dark Spread - - - 316 350 276 226 180

Biomass Spread - - - 46 52 133 331 463

Other Fuels Spread - - - 24 19 18 18 18Free CO2 Allocation - - - 131 129 0 0 0

Other Revenues - - - 28 28 28 28 28

Retail - - - (1 ) (1 ) 0 1 1

Grid Charges - - - (57 ) (59 ) (61 ) (63 ) (65 )

Operating Costs - - - (166 ) (187 ) (194 ) (190 ) (198 )

EBITDA - - - 321 331 200 352 427


Figure 47: Drax – Income statement (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

Total Revenue 1,753 1,476 1,648 1,863 1,882 1,987 2,349 2,708

Cost of Sales (1,130 ) (973 ) (1,098 ) (1,357 ) (1,344 ) (1,572 ) (1,786 ) (2,061 )

Operating Costs (169 ) (148 ) (160 ) (185 ) (207 ) (215 ) (211 ) (220 )

Adjusted EBITDA 454 355 391 321 331 200 352 427

Depreciation, Amortisation and Impairment Charges (46 ) (52 ) (52 ) (57 ) (58 ) (66 ) (73 ) (81 )

Adjusted Operating Profit 408 303 338 264 273 134 279 346

Net Finance Costs (22 ) (15 ) (23 ) (24 ) (13 ) (19 ) (35 ) (40 )

Adjusted PBT 386 288 315 240 260 116 243 306

Income Tax Expense (94 ) (83 ) (82 ) (51 ) (61 ) (22 ) (52 ) (73 )

Adjusted Net Income 292 204 233 189 199 94 192 233

Growth (%) -15.6% -30.1% 14.0% -18.8% 5.3% -52.9% 104.4% 21.2%Margin (%) 16.7% 13.8% 14.1% 10.2% 10.6% 4.7% 8.2% 8.6%



Growth (%) -13.3% -32.8% 10.2% -18.8% -1.4% -55.7% 104.4% 21.2%

DPS - Interim (p) 5.0 4.1 14.1 16.0 8.5 3.8 7.7 9.3

DPS - Final (p) 38.3 9.6 17.9 9.9 17.0 7.5 15.4 18.7

DPS - Special (p) 9.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0

DPS - Total (p) 53.0 13.7 32.0 25.9 25.6 11.3 23.1 28.0

Growth - Ordinary DPS (%) 196.6% -68.4% 133.6% -19.0% -1.4% -55.7% 104.4% 21.2%

Payout Ratio - Total DPS (%) 61.5% 23.7% 50.1% 50.0% 50.0% 50.0% 50.0% 50.0%





2 November 2011 41

Figure 48: Drax – Cash flow (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E

EBITDA (inc. cash exceptionals) 454 355 391 321 331 200 352 427

+/- Changes in Working Capital (21 ) (43 ) 115 (60 ) (11 ) (153 ) (94 ) 99

+ Share-Based Payments 4 2 3 3 3 3 3 3

+ Pension Charge 4 5 6 6 6 6 6 6

- Pension Contributions (10 ) (8 ) (8 ) (11 ) (11 ) (11 ) (11 ) (11 )

+/- Intangible Assets - ROC 0 10 (21 ) (5 ) (36 ) (110 ) (208 ) (135 )

- Net Interest Paid (19 ) (13 ) (20 ) (20 ) (11 ) (16 ) (30 ) (34 )

- Net Tax Paid (102 ) 19 (56 ) (63 ) (56 ) (17 ) (46 ) (61 )

+ Other Changes 0 0 2 0 0 0 0 0

Operating Cash Flow 310 328 411 169 216 (97 ) (29 ) 294

Capital Expenditure (91 ) (93 ) (62 ) (40 ) (182 ) (236 ) (237 ) (96 )

Free Cash Flow 218 235 349 129 34 (333 ) (266 ) 198

Acquisitions and Disposals 0 (12 ) 0 0 0 0 0 0

Change in Equity 0 106 0 0 250 0 0 0

Dividends Paid to Shareholders/Minorities (110 ) (145 ) (87 ) (124 ) (72 ) (86 ) (63 ) (103 )

Net Cash Flow 108 184 262 6 213 (420 ) (330 ) 95

Other Movements in Net Debt (6 ) (4 ) (4 ) 0 0 0 0 0

Financial Net (Debt)/Cash (235 ) (54 ) 204 210 422 3 (327 ) (232 )

Net Debt/EBITDA 0.5x 0.2x (0.5x) (0.7x) (1.3x) (0.0x) 0.9x 0.5x


Figure 49: Drax – Balance sheet (£m)

2008 2009 2010 2011E 2012E 2013E 2014E 2015E


Intangible Assets 0 22 44 49 85 195 403 538

Cash/Marketable Securities 130 135 331 220 632 413 283 303

Working Capital Assets 449 403 350 401 412 564 659 560

Other Assets 392 421 138 138 138 138 138 138

Total Assets 2,107 2,159 2,047 1,976 2,558 2,771 3,108 3,179

Short-Term Debt (15 ) (63 ) (62 ) (10 ) (10 ) (10 ) (10 ) (10 )

Long-Term Debt (350 ) (127 ) (65 ) 0 (200 ) (400 ) (600 ) (525 )

Working Capital Liabilities (295 ) (227 ) (285 ) (280 ) (281 ) (284 ) (290 ) (296 )

Provisions (23 ) (39 ) (44 ) (39 ) (34 ) (29 ) (24 ) (19 )

Other Liabilities (731 ) (679 ) (633 ) (423 ) (428 ) (433 ) (438 ) (451 )

Total Liabilities (1,414 ) (1,135 ) (1,089 ) (751 ) (953 ) (1,156 ) (1,362 ) (1,300 )

Shareholders' Equity 693 1,025 958 1,224 1,605 1,615 1,747 1,879

Total Equity 693 1,025 958 1,224 1,605 1,615 1,747 1,879





2 November 2011 42

COMPANY SNAPSHOT

SSE Integrated Utilities


EBITDA, adjusted 2,227 2,398 2,658 2,764 7.5% Stock Rating 2-EQUAL WEIGHT

EBIT, adjusted 1,455 1,533 1,726 1,792 7.2% Sector View 2-NEUTRAL

Pre-tax income, adjusted 1,310 1,382 1,521 1,545 5.7% P rice (31-Oct-2011) £13.44

Net income, adjusted 1,042 1,048 1,152 1,172 4.0% Price Target £12.35

EPS, adjusted (p) 112.3 111.8 122.7 124.6 3.5% Ticker RIC: SSE.L, BB: SSE LN

Diluted shares (m) 929 939 940 942 0.5%



EBITDA margin 7.6 8.0 8.6 8.8 8.3

EBIT margin 5.0 5.1 5.6 5.7 5.4

Pre-tax margin 4.5 4.6 4.9 4.9 4.7

Net margin 3.6 3.5 3.7 3.7 3.6

ROIC 11.1 10.7 11.2 11.0 11.0

ROA 6.1 5.9 6.4 6.4 6.2

ROE 25.0 19.7 20.5 19.8 21.2 Upside case £14.45

Balance sheet and cash flow (€m) CAGR

Net PP&E 8,518 9,634 10,534 11,374 10.1%

Total net assets 21,181 22,300 23,217 24,046 4.3%



Adjusted net debt (5,891) (6,801) (7,403) (7,962) NA

Cash flow from operations 1,719 1,520 1,720 1,779 1.1% Downside case £11.05

Capital expenditure (1,444) (1,694) (1,538) (1,515) NA

Free cash flow 276 (174) 182 263 -1.5%

Pre-dividend FCF 10 (174) 182 263 NA


EV/EBITDA (x) 8.3 8.1 7.5 7.5 7.8


Dividend yield (%) 5.6 5.9 6.2 6.5 6.1

FCF yield (%) 2.2 (1.4) 1.4 2.1 1.1

P/BV (x) 2.4 2.3 2.2 2.1 2.3

EV/IC (x) 1.6 1.5 1.5 1.5 1.5

Net debt/EBITDA (x) 3.0 3.2 3.1 3.2 3.1


Payout ratio (%) 66.8 71.3 68.2 70.5

Thermal Cap. (MW) 10,067 9,947 9,947 9,947

Renewable Cap. (MW) 2,445 2,866 3,501 3,692 Source: Thomson Reuters Datastream, Barclays Capital est.

Electricity Product. (TWh) 47.3 41.8 49.1 48.6 Renewable capacity (MW)

Resi. EBIT Margin (%) 9.7 6.3 4.4 6.0

Energy Customers (m) 9.2 9.1 9.0 9.0

RAB - Scotland (£m) 1,459 1,605 2,103 2,362

RAB - England (£m) 1,863 1,988 2,096 2,201

RAB - SGN (£m) 2,122 2,262 2,372 2,483

Source: Company data, Barclays Capital Note: FY end Mar.

Why a 2-EW? We see weak fundamentals in fossil

fuel generation and believe SSE will be at a

competitive disadvantage in the UK energy market,

despite its investment in renewables. However, this

is offset by SSE's exposure to regulated networks.

Our ups ide case ass umes s pa rk s preads rise by

£5/MWh and retail margins by 1%. We assume SSE

trades in line with SOTP.

Our downside case assumes retail margins decline

by a further 1% and SSE derates to 9.2x 2013/14E

P/E.

0

1000

2000

3000

4000

5000

2011A 2012E 2013E 2014E

Renewable Cap. (MW)

Downside

Case

$56

(-33.9%)

Price

Target

$69

(-18.6%)

Upside

Case

$75

(-11.5%)

28

48

68

88

108

9-Nov-09 2-Nov-10

Downside

Case

1105p

(-17.7%)

Price

Target

1235p

(-8.11%)

Upside

Case

1445p

(7.5%)

552

752

952

1152

1352

1552

1752

18-Nov-10 31-Oct-11




2 November 2011 43

SSE – STILL STRUGGLING FOR MOMENTUM

We see deteriorating fundamentals in SSE’s generation and supply business. Its large

ageing coal and gas fleet is likely to struggle to cover its fixed costs once free CO2

permits expire, and it has less earnings momentum in its UK cleaner generation fleet

than some of its competitors. As a result, we believe SSE will be at a competitivedisadvantage in the UK retail market, which could see market share and margins come

under pressure. However, risk to EPS is mitigated by SSE’s exposure to UK regulated

networks, specifically electricity transmission. We see just 2% downside to consensus

estimates. And whilst we expect a P/E de-rating, the downside is partially offset by a 5.9%

yield and potential for 6-7% dividend growth. We believe the risks to SSE’s shares are

therefore moderate when compared to the risks we see across other integrated utility

names. We initiate coverage with a 2-EW recommendation and a £12.45 price target.

Fossil fuel exposure acts as a drag

SSE has a significant pipeline of investment in clean generation, focused predominantly on wind.

However, our analysis in this report points to a very tough environment for older gas and coal-fired generation. With economic interests in 10GW of older fossil fuel capacity, as well as the

largest free CO2 allocation of the Big 6, we expect SSE’s exposure to dirty generation to hamper

its relative competitive position and act as a drag on overall earnings growth.

Figure 50: Annual EBITDA of 1GW power station on an unhedged basis, excluding free CO2 (£m)

2010 2011E 2012E 2013E 2014E 2015E 2016E

Hard Coal - 36% Efficiency (24.3 ) (11.0 ) 12.2 (6.7 ) (9.2 ) (17.2 ) (24.4 )

CCGT - 49% Efficiency 14.8 (6.4 ) (9.3 ) (10.3 ) (6.4 ) (8.4 ) 2.2


The last free CO2 allocations will be given to UK fossil fuel generators around February

2012. Once these have been used up, we believe owners of older capacity will struggle to

cover fixed costs. Specifically, we believe CCGT plant will be unable to cover its fixed costs

over the period from 2013-15E, while old coal plant will become permanently out-of-the

money from 2013 onwards (Figure 50). Indeed, we believe the period from 2013-15E has

the potential to be punishing for generators with significant exposure to old coal and CCGT

plant. Unfortunately, SSE has material exposure to both.

Figure 51: SSE – Economic interest in generating capacity (MW)

2009 2010 2011 2012E 2013E 2014E 2015E

Hard Coal 3,984 4,211 4,347 4,347 4,347 4,347 3,350

Gas/Oil 4,870 5,224 5,720 5,600 5,600 5,600 5,533

Renewable 2,226 2,375 2,445 2,866 3,501 3,692 3,875

Total 11,080 11,810 12,512 12,813 13,448 13,639 12,758


Competitive disadvantage in UK retail

SSE has been fast to respond to the political and regulatory criticism facing all of the Big 6. It

was the first to end doorstep selling, suspending it in July 2011 after it was found guilty of

mis-selling – the rest of the Big 6 are now following. It has been the first to scrap discounted

internet tariffs, to respond to accusations of predatory pricing by Chris Huhne, the UK

SSE.L / SSE LN

Stock Rating

2-Equal Weight

Sector View

2-Neutral

Price Target

£12.35

Price (31 Oct 2011)

£13.44


-8.1%

SSE has been fast to respond to

political pressure…




2 November 2011 44

Energy Secretary17. It has also written to both its customers and to Huhne, pledging a fairer

deal for its customers.

Whilst these actions may curry favour with politicians, help to increase customer loyalty and

reduce churn at the margin, we do not believe they will be enough to prevent SSE’s

downstream residential supply business from suffering a challenging few years.

As we discuss earlier, our analysis in this report concludes that EdF Energy and, to a lesser

extent, RWE npower have both the earnings momentum and the motivation to drive a more

aggressive pricing strategy in the downstream residential energy market. Unfortunately, the

pressure on earnings in SSE’s fossil fuel generation fleet, as well as the need to earn a return

on capital on its renewables investment means we believe SSE will not be well positioned to

compete on price.

This is already starting to show. SSE had typically priced towards the bottom end of the Big

6, though since the start of 2010, only British Gas has increased tariffs by more (Figure 52).

That now places SSE towards the top of the pack on weighted average sales price ( Figure

53). As a result, we expect SSE to start losing market share in UK downstream retail for the

first time since competition began. Indeed, SSE has flagged in recent analyst meetings that

it had lost customers in 1H11/12.

Renewables growth finally starting to come through

We forecast that FY11/12E will be the fourth consecutive year of sub-3% EPS growth for

SSE (in fact we forecast a 0.5% decline). However, FY12/13E should see a 10% jump in EPS,

as a number of SSE’s high profile wind projects reach commissioning (specifically Clyde,

Griffin, Greater Gabbard and Walney), increasing capacity to SSE’s target of 3.5GW.

Thereafter, we expect that momentum to slow: SSE’s advanced offshore development

pipeline is 1.1GW, and there are no additional offshore wind projects expected to come on

stream before 2015/16 (after which the ROC banding drops to 1.9x, then 1.8x).

17 “It is not fair that big energy companies can push their prices up for the vast majority of their consumers – who do

not switch – while introducing cut-throat offers for new customers that stop small firms entering the market … that looks to me like predatory pricing. It must and will stop” , Chris Huhne’s speech at the Liberal Democrat partyconference, 20 September 2011.

…but commercial pressure will

be more challenging to manage

Figure 52: Average dual fuel price increase since March 2010 Figure 53: Average estimated dual fuel weighted averagesales price* (Index = 100)

26%23% 22% 21% 20%

18%

0%

5%

10%

15%

20%

25%

30%

B r i t i s h G a s

S S E

E . On U K

S c o t t i s h P o w e r

E D F E n e r g y

R WE n p o w e r

112

107 107105

104

100

90

95

100

105

110

115

B r i t i s h G a s

S S E

S c o t t i s h P o w e r

E . OnE n e r g y

R WE n p o w e r

E d F E n e r g y

Source: Barclays Capital, company data. Source: Barclays Capital, company data.

* See note to Figure 29 for methodology and caveats.

We expect SSE to hit its target of

3.5GW renewables in 2013




2 November 2011 45

SSE is also investigating options to develop cleaner generation at some of its existing coal

plant: it recently received consent to develop up to 108MW multi-fuel project at Ferrybridge,

with potential completion in early 2015, and is developing a project to repower its

Uskmouth plant into a 100MW biomass unit. However, both these projects are small

compared to RWE’s conversion of Tilbury into a 750MW dedicated biomass plant and

Drax’s plans to develop 2GW of co-firing capacity.

Networks underpin earnings

It is important to remember that regulated network activities continue to represent 40% of

SSE’s Adjusted EBIT. These have benefited from high RPI over the last two years, though

Barclays Capital’s economists expect UK RPI to decline from 5.7% y/y in October 2011E to

2.9% in January 2013E. Nonetheless, this could be more than offset by a substantial tariff

increase for Scottish Hydro Electricity Transmission (SHELT) on 1 April 2012 – the TCPR4 18

rollover initial proposal is currently for a 31% real tariff increase – and the potential for

accelerating regulated asset value (RAV) growth. We currently forecast SHELT’s RAV to

grow from £0.5bn in FY10/11 to £1.8bn by FY17/18E. However, SHELT has identified

growth projects that could see RAV hit £3.0bn by FY17/18E even if only 50% of them were

to be allowed by Ofgem.

Figure 54: SSE – Projected RAV growth (£m)

Year ending 31 March 2009 2010 2011 2012E 2013E 2014E 2015E

Southern Electric Power Distribution 1,729 1,820 1,863 1,988 2,096 2,201 2,299

Scottish Hydro Power Distribution 840 869 927 970 1,002 1,031 1,064

Scottish Hydro Electricity Transmission 387 419 533 635 1,101 1,331 1,522

Scotia Gas Networks 1,815 1,959 2,122 2,262 2,372 2,483 2,593

Total RAV 4,770 5,067 5,444 5,855 6,571 7,045 7,478

SHETL upside from 50% business plan growth projects - - - - - 219 520

SHETL upside from 100% business plan growth projects - - - - - 438 1,039


Stable earnings, but balance sheet becoming more stretched

Overall, we believe SSE will have a relatively stable financial outlook from an earnings

perspective, though we believe its balance sheet is becoming more stretched due to a high

ongoing level of capex.

Modest EPS downgrade risk. We believe the ongoing pressures we see in SSE’s

generation and supply business will be largely offset by stronger growth in electricity

transmission. As a result, we currently see only around 2% downside to consensus EPS

estimates for FY11/12E-FY14/15E.

Balance sheet becoming more stretched. Compared to its integrated utility peers, SSE

has relatively high net debt/EBITDA. Whilst one could argue that this is justified given

the large proportion of regulated network activities in its earnings mix, stripping out

networks reveals that net debt/EBITDA in the non-regulated business could grow to

4.2x. However, we believe SSE could mitigate this by financing new wind farm projects

(especially offshore) off balance sheet.

18 Transmission Price Control Review 4

SSE has exposure to UK

electricity transmission upside




2 November 2011 46

Figure 55: SSE – Adjusted net debt/EBITDA analysis (£m)

Year ending 31 March 2009 2010 2011 2012E 2013E 2014E 2015E

Adjusted Net Debt (5,100 ) (5,292 ) (5,891 ) (6,801 ) (7,403 ) (8,412 ) (9,541 )

of which: Networks @ 70% Debt/RAV (2,069 ) (2,176 ) (2,326 ) (2,515 ) (2,939 ) (3,194 ) (3,419 )

Adjusted Net Debt/EBITDA - Group 3.0x 2.8x 3.0x 3.2x 3.1x 3.2x 3.2x

Adjusted Net Debt/EBITDA - Networks 3.9x 3.7x 3.3x 3.3x 3.5x 3.5x 3.4x

Adjusted Net Debt/EBITDA - Non-Regulated 2.6x 2.7x 3.1x 3.7x 3.8x 4.1x 4.2x

Adjusted Net Debt/EBITDA - Non-Regulated (ex. new offshore) 2.6x 2.7x 3.1x 3.7x 3.8x 4.0x 4.0x


Moderate earnings and dividend growth. We forecast FY11/12-FY14/15E EPS CAGR of

6.9%, and therefore we believe SSE will be able to continue to deliver on its promise of

sustained dividend growth. We forecast DPS to grow at a 6.7% CAGR FY11/12-

FY14/15E.

P/E analysis justifies a £12.35 price target

Our SOTP valuation for SSE is £12.65. However, as with Centrica, we think P/E analysis may

give a clearer indication of where SSE’s shares could trade on a 12-month view.

Figure 56 shows that, over the past five years, SSE has on average traded at a -0.1 point Y+2

P/E discount to the Stoxx Utilities index, with a standard deviation of -0.8 to +0.6. Based on

current consensus 2013E EPS, SSE is trading at 10.5x FY13/14E P/E, compared to an

average Y+2 P/E for the Stoxx Utilities index of 10.0x this year (current Y+2 P/E is 9.9x).

Similar to Centrica, given the deteriorating fundamentals of its generation and supply

activities, we believe SSE should de-rate to at least its historical average discount of -0.1x,

implying a target 2013E P/E of 9.9x. When coupled with our FY13/14E EPS forecast of

124.6p (2% below consensus), this implies a target price of £12.35 – just a 2% discount to

our SOTP valuation.

Figure 56: SSE – average forward P/E premium/discount vs. Stoxx Utilities

-2.0x

-1.5x

-1.0x

-0.5x

0.0x

0.5x

1.0x

1.5x

2.0x

Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Y+1 Y+2

SSE has on average traded at a

0.1 point P/E discount to

European Utilities

Source: Bloomberg, Barclays Capital.




2 November 2011 47

Figure 57: SSE – SOTP valuation (as at 31 December 2011)

£m p/share %EVEV/EBITDA -

2012E

EV/EBITDA -

2014E

CAGR 2012-

15E

Generation - Coal (735 ) (78 ) -4% - - -

Generation - Gas/Oil 120 13 1% - - -

Generation - Renewable 9,197 980 44% - - -

Generation - EUA Allowance 104 11 0% - - -

Supply 4,192 447 20% - - -

Generation and Supply 12,879 1,372 61% 11.5x 10.1x 7.1%

Power Systems - SE Distribution 2,441 260 12% - - -

Power Systems - SH Distribution 1,158 123 6% - - -

Power Systems - SH Transmission 642 68 3% - - -

Scotia Gas Networks 2,332 248 11% - - -

Networks 6,573 700 31% 6.4x 5.5x 7.9%

Other - Gas Storage 346 37 2% - - -

Other - Gas Production 296 31 1% - - -

Other - Contracting, Connections and Metering 745 79 4% 6.0x - -

Other - Telecoms 154 16 1% 6.0x - -

Other - Property and Corporate Services 19 2 0% 6.0x - -

Other 1,559 166 7% 5.8x 5.2x 3.1%

Corporate Costs (32 ) (3 ) 0% 6.0x - -

Enterprise Value 20,980 2,235 - 9.0x 7.8x 7.0%

Net Debt - Adjusted (5,639 ) (601 )

Net Debt - Scotia Gas Networks (1,569 ) (167 )

Net Debt - Hybrid Capital (1,161 ) (124 )

Net Pension Deficit (553 ) (59 )

Provisions (179 ) (19 )

Minorities 0 0

Equity Value 11,878 1,265





2 November 2011 48

Figure 58: SSE – Financial ratios and valuation multiples

Year ending 31 March 2009 2010 2011 2012E 2013E 2014E 2015E 2016E

EPS/DPS


DPS - Total (p/share) 66.0 70.0 75.0 79.7 83.6 87.8 92.2 96.8

Valuation Multiples

P/E (x) - - 12.0x 12.0x 11.0x 10.8x 9.9x 10.4x

EV/EBITDA - exc. Assoc (x) - - 8.7x 8.5x 7.9x 7.8x 7.5x 7.7x

EV/EBITDA - inc. Assoc (x) - - 8.3x 8.1x 7.5x 7.5x 7.2x 7.3x

EV/NOPAT (x) - - 15.5x 15.1x 13.8x 13.6x 12.7x 13.1x

Dividend Yield (%) - - 5.6% 5.9% 6.2% 6.5% 6.9% 7.2%

FCF Yield (%) - - 2.2% -1.4% 1.4% 2.1% 3.7% 4.7%

P/BV (x) - - 2.4x 2.3x 2.2x 2.1x 2.0x 1.9x

EV/IC (x) - - 1.6x 1.5x 1.5x 1.5x 1.4x 1.4x

Financial Ratios


Adjusted Net Debt/EBITDA (x) 3.0x 2.8x 3.0x 3.2x 3.1x 3.2x 3.2x 3.3x

ROE 32.0% 33.3% 25.0% 19.7% 20.5% 19.8% 20.4% 18.6%

ROIC 13.7% 12.4% 11.1% 10.7% 11.2% 11.0% 11.4% 10.8%

WACC - - 7.0% 7.0% 7.0% 7.0% 7.0% 7.0%

Weighted Ave. Shares (mm) 883 922 928 938 939 941 942 944

Source: Barclays Capital, company data, DataStream.

Figure 59: SSE – Segmental operating profit (£m)


Power Systems - Scotland 160 159 168 199 243 264 298 273

Power Systems - England 243 257 287 292 327 357 386 295

Scotia Gas Networks 181 184 187 200 215 210 214 219

Generation and Supply 832 896 883 892 975 987 1,076 1,146

Other Businesses 134 140 137 164 181 189 190 187

Unallocated Expenses (9 ) (10 ) (9 ) (9 ) (9 ) (9 ) (9 ) (9 )

Adjusted EBIT 1,541 1,626 1,653 1,737 1,932 1,998 2,156 2,112

JV & Associate Tax/Interest (168 ) (157 ) (198 ) (204 ) (207 ) (206 ) (211 ) (217 )


Growth (%) 13.2% 6.9% -1.0% 5.4% 12.5% 3.9% 8.5% -2.5%

Margin (%) 5.2% 6.6% 5.0% 5.1% 5.6% 5.7% 6.2% 6.0%





2 November 2011 49

Figure 60: SSE – Income statement (£m)


External Revenue 25,424 21,550 28,334 29,020 29,719 30,135 30,265 30,618

Costs (23,799 ) (19,771 ) (26,463 ) (26,996 ) (27,453 ) (27,762 ) (27,725 ) (28,111 )

Associates - EBIT 246 264 299 312 327 322 326 331Adjusted EBITDA 1,872 2,043 2,170 2,336 2,592 2,694 2,866 2,839

Depreciation and Amortisation (330 ) (417 ) (518 ) (599 ) (660 ) (696 ) (710 ) (727 )

Adjusted EBIT 1,541 1,626 1,653 1,737 1,932 1,998 2,156 2,112

Associates - Interest (128 ) (107 ) (140 ) (144 ) (145 ) (145 ) (151 ) (156 )

Adjusted Net Finance Cost (160 ) (229 ) (203 ) (211 ) (266 ) (308 ) (328 ) (352 )

Adjusted PBT 1,254 1,290 1,310 1,382 1,521 1,545 1,677 1,604

Associates - Tax (12 ) (16 ) (23 ) (24 ) (26 ) (26 ) (25 ) (25 )

Current Tax (289 ) (258 ) (245 ) (262 ) (296 ) (300 ) (324 ) (308 )

Effective Tax Rate (%) 24.0% 21.2% 20.3% 19.0% 19.0% 19.0% 19.0% 19.0%

Minority Interests 0 (0 ) 0 0 0 0 0 0

Hybrid Capital 0 0 0 (47 ) (47 ) (47 ) (47 ) (47 )

Adjusted Net Income 953 1,016 1,042 1,048 1,152 1,172 1,280 1,223

Growth (%) 4.5% 6.6% 2.6% 0.6% 9.9% 1.7% 9.3% -4.5%

Margin (%) 3.6% 4.5% 3.6% 3.5% 3.7% 3.7% 4.1% 3.8%



Growth (%) 2.3% 2.0% 1.9% -0.5% 9.8% 1.5% 9.0% -4.7%

DPS - Interim (p) 19.8 21.0 22.4 24.2 25.5 26.7 28.1 29.5

DPS - Final (p) 46.2 49.0 52.6 55.5 58.1 61.1 64.1 67.3DPS - Total (p) 66.0 70.0 75.0 79.7 83.6 87.8 92.2 96.8

Growth - Ordinary DPS (%) 9.1% 6.1% 7.1% 6.2% 5.0% 5.0% 5.0% 5.0%

Payout Ratio (%) 61.1% 63.5% 66.8% 71.3% 68.2% 70.5% 67.9% 74.8%





2 November 2011 50

Figure 61: SSE – Cash flow (£m)


Operating Profit 1,398 1,362 1,354 1,425 1,605 1,676 1,830 1,781

Depreciation, Amortisation and Impairment Losses 330 417 518 599 660 696 710 727

Change in Working Capital (1,218 ) 525 324 0 0 0 0 0Changes in Provisions/Other Non-Cash Items (193 ) (90 ) (88 ) (88 ) (88 ) (88 ) (88 ) (88 )

Dividends from Associates 40 22 82 54 60 58 57 57

Income Tax (145 ) (239 ) (277 ) (236 ) (278 ) (309 ) (333 ) (349 )

Net Interest (259 ) (308 ) (194 ) (235 ) (240 ) (255 ) (282 ) (300 )

Operating Cash Flow (46 ) 1,689 1,719 1,520 1,720 1,779 1,894 1,828

Capital Expenditure (1,280 ) (1,315 ) (1,444 ) (1,694 ) (1,538 ) (1,515 ) (1,426 ) (1,231 )

Free Cash Flow (1,326 ) 374 276 (174 ) 182 263 467 596

Acquisitions and Disposals 82 (86 ) (275 ) 0 0 0 0 0

Change in Equity 480 7 9 0 0 0 0 0

Dividends Paid to Shareholders/Minorities (552 ) (619 ) (514 ) (736 ) (784 ) (822 ) (865 ) (908 )

Net Cash Flow (1,316 ) (323 ) (504 ) (910 ) (602 ) (559 ) (397 ) (312 )

Other Movements in Net Debt (118 ) 131 (95 ) 0 0 0 0 0

Adjusted Net Cash/(Debt) (5,100 ) (5,292 ) (5,891 ) (6,801 ) (7,403 ) (7,962 ) (8,359 ) (8,671 )

Net Debt/EBITDA 3.0x 2.8x 3.0x 3.2x 3.1x 3.2x 3.2x 3.3x


Figure 62: SSE - Balance sheet (£m)



Intangible Assets 977 1,015 973 952 930 909 887 866

Investments 937 1,615 1,925 1,979 2,039 2,097 2,155 2,212

Cash/Marketable Securities 296 262 477 448 426 377 310 202

Working Capital Assets 6,026 4,723 5,286 5,286 5,286 5,286 5,286 5,286

Other Assets 2,301 2,305 4,003 4,003 4,003 4,003 4,003 4,003

Total Assets 17,769 18,128 21,181 22,300 23,217 24,046 24,752 25,206

Short-Term Debt (1,060 ) (904 ) (447 ) (447 ) (447 ) (447 ) (447 ) (447 )

Long-Term Debt (4,336 ) (5,143 ) (5,160 ) (6,041 ) (6,621 ) (7,132 ) (7,461 ) (7,665 )

Working Capital Liabi li ties (4,791 ) (4,389 ) (5,382 ) (5,269 ) (5,170 ) (5,081 ) (4,988 ) (4,903 )

Provisions (348 ) (810 ) (848 ) (848 ) (848 ) (848 ) (848 ) (848 )

Other Liabilities (4,260 ) (3,761 ) (4,413 ) (4,509 ) (4,628 ) (4,722 ) (4,829 ) (4,899 )

Total Liabilities (14,794 ) (15,007 ) (16,250 ) (17,113 ) (17,713 ) (18,229 ) (18,572 ) (18,761 )

Shareholders' Equity 2,977 3,125 5,201 5,457 5,774 6,086 6,449 6,714

Minority Interest/Other (2 ) (4 ) 0 0 0 0 0 0

Total Equity 2,975 3,121 5,201 5,457 5,774 6,086 6,449 6,714





2 November 2011 51

This page is intentionally left blank




2 November 2011 52

COMPANY SNAPSHOT

NATIONAL GRID European Utilities


EBITDA 4,291 4,906 5,071 5,533 8.8% Stock Rating 1-OVERWEIGHT

EBIT 3,121 3,600 3,638 3,970 8.3% Sector View 2-NEUTRAL

Pre-tax income 1,974 2,473 2,545 2,696 11.0% P rice (31-Oct-2011) 618p

Net income 1,421 1,751 1,781 1,887 9.9% Price Target 680p

EPS (p) 50.2 51.7 49.9 51.9 1.1% Ticker NG/ LN

Diluted shares (m) 2,476 3,374 3,549 3,614 13.4%



EBITDA margin 30.6 34.2 34.0 35.7 33.6

EBIT margin 22.3 25.1 24.4 25.6 24.3

Pre-tax margin 14.1 13.8 16.6 16.4 15.2

Net margin 10.1 12.2 12.0 12.2 11.6

ROIC 8.5 9.3 8.7 8.7 8.8

ROA 3.9 4.7 4.5 4.4 4.4

ROE 33.7 19.3 17.9 17.6 22.1 Upside case 720p

Balance sheet and cash flow (£m) CAGR

Net PP&E 36,994 37,961 40,177 42,862 5.0%

Total net assets 36,153 37,596 39,797 42,468 5.5%



Net debt (22,139) (18,700) (20,045) (21,994) NA

Operating cash flow 3,275 3,454 3,031 3,389 1.1% Downside case 590p

Capital expenditure (3,176) (3,600) (3,649) (4,249) NA

Free cash flow (589) (968) (1,632) (1,950) NA

Pre-dividend FCF 99 (146) (618) (860) NA


EV/EBITDA (x) 9.4 8.7 8.9 8.6 8.9

EV/EBIT (x) 13.0 11.8 12.4 11.9 12.3 Upside/downside scenarios

FCF yield (%) -3.8 -4.6 -7.4 -8.7 -6.2

Price/BV (x) 3.6 2.3 2.2 2.1 2.6

Dividend yield (%) 6.2 5.9 6.4 6.5 6.2

Total debt/capital (%) 84.0 67.3 66.8 67.2 71.3

Net debt/EBITDA (x) 5.2 3.8 4.0 4.0 4.2

Selected operating metrics CAGR

Dividend payout ratio 76.7 70.4 78.7 77.2

Interest cover 2.70 3.17 3.31 3.45

UK RAV (£m) 18,940 20,348 22,365 24,922 9.6% Source: Thomson Reuters Datastream, Barclays Capital est.

US Asset Base (£m) 9,788 9,241 10,236 10,817 3.4% EBITDA (£m) and ROIC

Premium to RAV (%) 2.14 5.89 3.23 0.80 -28.0%

Source: Company data, Barclays Capital Note: FY end March.

Why 1-Overweight? NG benefits from diversification

by activity (mainly transmission and distribution)

and geography (UK and US). The dividend policy,

together with growth in the regulatory asset base,

posi tions NG as the most attractive inves tment

opportunity within European regulated utilities, in

our view.

We assume unchanged blended returns in the UK

post RIIO introduction, a target ROE for US activities

of10%, an increase of100bpsin domestic RPI and a

decline of 100bps in 10- year bond yields.

We assume a cut in the blended return on UK assets

post RIIO of 200bps , an unchanged ROE for US

activities, a decline of 200bps in domestic RPI and an

increase of 200bps in 10-year bond yields.

0

1000

2000

3000

4000

5000

6000

2010A 2011E 2012E 2013E

5%

6%

7%

8%

9%

10%EBITDA ROIC

Downside

Case

610p

(-0.73%)

Price

Target

640p

(4.1%)

Upside

Case

670p

(9.0%)

242

342

442

542

642

742

18-Nov-10 31-Oct-11

Downside

Case

590p

(-4.14%)

Price

Target

680p

(10.4%)

Upside

Case

720p

(16.9%)

242

342

442

542

642

742

842

18-Nov-10 31-Oct-11

Downside

Case

590p

(-4.45%)

Price

Target

680p

(10.1%)

Upside

Case

720p

(16.5%)

265

365

465

565

665

765

865

18-Nov-10 31-Oct-11




2 November 2011 53

NATIONAL GRID – PROACTIVE ASSET MANAGEMENT STARTED

For exposure to UK electricity transmission, our preferred play remains National Grid.

The RIIO regulatory review, which will define new tariffs from April 2013, enters into its

central phase in the second half of next year. Preparing for that, the company has

already started to follow a strategy of asset rationalisation, which will result, in ourview, in a cleaner structure and more focused business lines. In the medium term, we

see two main drivers of performance for the stock: 1) the implementation a regulatory

framework which should stimulate rapid RAV growth; 2) a financing strategy with

ongoing asset rationalisation aimed at achieving the highest possible blended return on

the company’s invested capital. Our rating on National Grid remains 1-OW.

RIIO will be something for next year

The ongoing review, which will regulate tariffs from 1st April 2013, will be finalised during

the second half of 2012. What emerged from recent publications from National Grid and the

regulator is that the system will require £30.7bn of new investments into networks. This

could translate into very significant UK Transmission RAV growth.

Figure 63: National Grid’s RAV evolution - Transmission

0

5,000

10,000

15,000

20,000

25,000

30,000

2012/13E 2014/15E 2016/2017E 2018/2019E 2020/2021E

Gas Electrici ty

Source: National Grid, Ofgem, Barclays Capital

We therefore expect Ofgem to create a balanced structure allowing companies to maintain

attractive rate of returns and where future increases for customers will be compensated by

effective improvements in the level of service. For this reason, we think that the base

allowed return is just one, important but single, component of the equation and that the

new RIIO system will have to be judged in its entire form, including incentives and

transitional arrangements.

Before year end, National Grid will face a small regulatory review; the rollover until March

2013 of the current framework. The final proposals will be out on 21 st November and, as

pointed out in our report “ Constructive TPCR4 Rollover ” , 2 August 2011, we believe it is the

firm intention of the regulator to minimise regulatory changes; we therefore expect a broad

confirmation of the structure, incentives and base return. In our model, we factor in just a

small fine-tuning of the vanilla return for transmission activities, from the current 5.05%

down to 4.75% on a change to the base risk free rate.

NG.L / NG/ LN

Stock Rating

1-Overweight

Sector View

2-Neutral

Price Target

£6.80

Price (31 Oct 2011)

£6.18


10.1%

https://live.barcap.com/go/publications/content?contentPubID=FC1735448

https://live.barcap.com/go/publications/content?contentPubID=FC1735448




2 November 2011 54

US rate cases likely in 2012 as well

Also in 2012, we anticipate that the company will file a general rate case in New York and

Rhode Island for both Niagara Mohawk and Narragansett. These two subsidiaries constitute

the US assets that continue to under earn their allowed returns. Management structure

realignment by regulatory region and their $200 million cost cutting programme should

both bolster regulatory relationships and show the intent of the company to do its part tokeep cost of service reasonable. We believe this should provide a framework for

constructive regulatory outcomes in both regions by 2013. However, if these regulatory

outcomes are not satisfactory, we would not be surprised if the company began to think

strategically about the long-term viability of its two under-earning US assets. That said, we

continue to believe that a wholesale disposal of the entire US business remains off the table.

Now we see the company focused on asset rationalisation

We believe National Grid’s strategy will continue to focus on asset rationalisation. Recently

the company announced the disposal of OnStream, a small part of its metering business, for

a total consideration of £274.3m, which pointed to solid implied multiples19. In addition, the

company has also disposed of non-core assets in the US. On 8 December 2010, National

Grid sold Granite State Electric and Energy North in New Hampshire to Algonquin Power &

Utilities for £178m, which represented a solid implied multiple of 11.9x 31 March 2010

EBITDA. Also, on 26 September 2011 the company sold Seneca-Upshur Petroleum to PDC

Mountaineer for approximately £95m.

Those two transactions, even if small, in our opinion support the group’s intention to

maximise implied IRRs in its portfolio of activities and we think this rationalisation process

will continue with the aim to fund better returns assets with the proceeds.

We continue to be positive on the stock

We do not see a risk of a short-term need of capital and we believe that the RIIO system can

offer the right mechanisms to stimulate investments without diluting shareholder returns.

Among regulated utilities, we think that National Grid represents an attractive equity story

where future investments will fuel growth and the company, uniquely in the European

market, is in a ramp-up phase of its capex rather than living in more mature markets.

Figure 64: Pan-European regulated energy utility valuation multiples

Company Rating

Target

Price

Current

Price

Potential up

/(downside)Div. Yield TSR Dividend Payout Ratio

2011E 2012E 2013E 2011E 2011E 2012E 2013E

Enagas 1-OW € 16.50 € 14.27 15.6% 6.1% 6.6% 7.0% 21.8% 60.0% 60.0% 60.0%

National Grid 1-OW £6.80 £6.18 10.1% 6.1% 6.4% 6.5% 16.2% 74.9% 76.2% 93.1%

Red Electrica 2-EW € 39.00 € 34.98 11.5% 4.9% 5.7% 6.6% 16.4% 60.5% 60.5% 60.5%REN 2-EW € 2.50 € 2.10 18.9% 8.2% 8.3% 8.5% 27.1% 85.2% 82.3% 83.0%

Snam RG 1-OW € 3.80 € 3.52 7.9% 6.8% 6.9% 7.2% 14.7% 85.2% 82.3% 83.0%

Terna 1-OW € 3.15 € 2.77 13.9% 7.6% 6.9% 6.9% 21.5% 114.8% 99.4% 96.2%

Average 13.0% 6.6% 6.8% 7.1% 19.6% 80.1% 76.8% 79.3%

Source: Barclays Capital, Thomson Reuters. Shares prices as at 31 October 2011.

19 We estimate an implied EV/EBITDA March 12 of 7.3x.

We expect constructive

regulatory outcomes

NG has an ongoing asset

disposal strategy

We reiterate our 1-OW

recommendation




2 November 2011 55

Valuation Methodology and Risks

European Utilities

Centrica (CNA LN / CNA.L)

Valuation Methodology: We value Centrica using a SOTP based on divisional DCF models. We assume a 5.0% long-term BGRE EBIT margin andmarked-to-market commodity prices. We use a post-tax nominal WACC of 7.7%, reflecting Centrica's relatively low gearing. However, given

challenging market conditions, we believe Centrica is likely to trade at a discount to SOTP. Based on its historic valuation range relative to theStoxx Utilities, we believe Centrica should trade on 9.5x 2013E P/E. This is how we derive our £2.60 price target.

Risks which May Impede the Achievement of the Price Target: The outlook for Centrica's earnings and valuation is dependant on a number of factors, most notable the evolution of energy prices. In the short-term, a fall in wholesale energy prices would improve Centrica's competitiveposition, though in the long-term it would reduce valuation in our view. A more benign regulatory environment would allow Centrica to earn ahigher than expected retail margin. On the downside, growing competition, slowing economic growth or regulatory risk may inhibit futuregrowth both in the UK and US.

Drax Group (DRX LN / DRX.L)

Valuation Methodology: We value Drax based on a DCF valuation model. We assume a 7.6% post-tax WACC and mark our commodity priceassumptions to market. Our central scenario assumes that Drax converts to 50% biomass co-firing by 2015, with biomass costs at 2.2x coal onaverage. However, we also assign a 15% probability to Drax converting to 100% biomass by 2020. In combination, this leads to a £6.75 pricetarget.

Risks which May Impede the Achievement of the Price Target: Drax is a risky stock and several uncertainties remain, which could trigger bothupside and downside risks: 1) future ROC bandings or feed-in tariff support; 2) the level of capex required to convert the plant; 3) technical

uncertainties, including the impact of conversion on thermal efficiency; 4) capital structure; 5) biomass availability and price; 6) the overall levelof power prices. Drax's DCF is highly sensitive to these assumptions.

SSE (SSE LN / SSE.L)

Valuation Methodology: We value SSE using a SOTP based on divisional DCF models. We assume a 5.0% long-term retail margin and marked-to-market commodity prices. We use a post-tax nominal WACC of 7.0%. However, given challenging market conditions, we believe SSE is likelyto trade at a discount to SOTP. Based on its historic valuation range relative to the Stoxx Utilities, we believe SSE should trade on 9.9x 2013E P/E.This is how we derive our £12.35 price target.

Risks which May Impede the Achievement of the Price Target: SSE's power generation business is exposed to spark spreads, dark spreads andabsolute power prices. These could drive both upside and downside to the shares. SSE's network assets are exposed to UK RPI, and haveupcoming regulatory reviews which could alter returns. SSE's balance sheet is relatiev stretched which could impede future investments. SSE's UKsupply business is at risk should aggressive price competition break out.

Source: Barclays Capital




2 November 2011 56

ANALYST(S) CERTIFICATION(S)

We, Peter Bisztyga, Monica Girardi, Julie Arav, Susanna Invernizzi, Harry Wyburd, Daniel Ford, CFA and Ross A. Fowler, CFA, hereby certify (1) thatthe views expressed in this research report accurately reflect our personal views about any or all of the subject securities or issuers referred to inthis research report and (2) no part of our compensation was, is or will be directly or indirectly related to the specific recommendations or viewsexpressed in this research report.

IMPORTANT DISCLOSURES CONTINUED

For current important disclosures, including, where relevant, price target charts, regarding companies that are the subject of this research report,please send a written request to: Barclays Capital Research Compliance, 745 Seventh Avenue, 17th Floor, New York, NY 10019 or refer tohttp://publicresearch.barcap.com or call 1-212-526-1072.

The analysts responsible for preparing this research report have received compensation based upon various factors including the firm's totalrevenues, a portion of which is generated by investment banking activities.

Research analysts employed outside the US by affiliates of Barclays Capital Inc. are not registered/qualified as research analysts with FINRA.These analysts may not be associated persons of the member firm and therefore may not be subject to NASD Rule 2711 and incorporated NYSERule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst’saccount.

Barclays Capital produces a variety of research products including, but not limited to, fundamental analysis, equity-linked analysis, quantitativeanalysis, and trade ideas. Recommendations contained in one type of research product may differ from recommendations contained in othertypes of research products, whether as a result of differing time horizons, methodologies, or otherwise.

Primary Stocks (Ticker, Date, Price)

Centrica (CNA.L, 31-Oct-2011, GBP 2.97), 3-Underweight/2-Neutral

Drax Group (DRX.L, 31-Oct-2011, GBP 5.43), 1-Overweight/2-Neutral

National Grid Plc (NG.L, 31-Oct-2011, GBP 6.18), 1-Overweight/2-Neutral

SSE (SSE.L, 31-Oct-2011, GBP 13.44), 2-Equal Weight/2-Neutral

Materially Mentioned Stocks (Ticker, Date, Price)

E.ON (EONGn.DE, 31-Oct-2011, EUR 17.51), 3-Underweight/2-Neutral

Enagas SA (ENAG.MC, 31-Oct-2011, EUR 14.27), 1-Overweight/2-Neutral

Endesa S.A. (ELE.MC, 31-Oct-2011, EUR 17.26), 1-Overweight/2-Neutral

Enel SpA (ENEI.MI, 31-Oct-2011, EUR 3.41), 1-Overweight/2-Neutral

Fortum (FUM1V.HE, 31-Oct-2011, EUR 17.63), 2-Equal Weight/2-Neutral

Gas Natural SDG SA (GAS.MC, 31-Oct-2011, EUR 13.49), 2-Equal Weight/2-Neutral

GDF Suez SA (GSZ.PA, 31-Oct-2011, EUR 20.52), 3-Underweight/2-Neutral

Iberdrola SA (IBE.MC, 31-Oct-2011, EUR 5.26), 3-Underweight/2-Neutral

International Power Plc (IPR.L, 31-Oct-2011, GBP 3.38), 1-Overweight/2-Neutral

Red Electrica Corporacion SA (REE.MC, 31-Oct-2011, EUR 34.98), 2-Equal Weight/2-Neutral

Redes Energeticas Nacionais (RENE.LS, 31-Oct-2011, EUR 2.10), 2-Equal Weight/2-Neutral

RWE (RWEG.DE, 31-Oct-2011, EUR 30.95), 3-Underweight/2-Neutral

Snam Rete Gas SpA (SRG.MI, 31-Oct-2011, EUR 3.52), 1-Overweight/2-Neutral

Terna SpA (TRN.MI, 31-Oct-2011, EUR 2.77), 1-Overweight/2-Neutral

Verbund (VERB.VI, 31-Oct-2011, EUR 21.04), 2-Equal Weight/2-Neutral

Other Material Conflicts

GSZ.PA: Barclays Capital is acting as advisor to GDF Suez SA on the proposed joint sale of 10% of GDF Suez LNG Liquefaction SA and of a 30%minority stake in GDF SUEZ E&P International SAS to China Investment Corporation

Barclays Capital is acting as advisor to GDF Suez SA on the proposed sale of the 22.5% stake in Elgin Franklin Oil & Gas Limited owned by GDFSUEZ to ENI S.p.A

Guide to the Barclays Capital Fundamental Equity Research Rating System:

Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2-Equal Weight or 3-Underweight (see definitionsbelow) relative to other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (the “sectorcoverage universe”).

In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-




2 November 2011 57


Negative (see definitions below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investorsshould carefully read the entire research report including the definitions of all ratings and not infer its contents from ratings alone.

Stock Rating

1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-monthinvestment horizon.

2-Equal Weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.

3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-monthinvestment horizon.

RS-Rating Suspended - The rating and target price have been suspended temporarily due to market events that made coverage impracticable orto comply with applicable regulations and/or firm policies in certain circumstances including when Barclays Capital is acting in an advisorycapacity in a merger or strategic transaction involving the company.

Sector View

1-Positive - sector coverage universe fundamentals/valuations are improving.

2-Neutral - sector coverage universe fundamentals/valuations are steady, neither improving nor deteriorating.

3-Negative - sector coverage universe fundamentals/valuations are deteriorating.

Below is the list of companies that constitute the "sector coverage universe":

European Utilities

Centrica (CNA.L) Drax Group (DRX.L) E.ON (EONGn.DE)

Enagas SA (ENAG.MC) Endesa S.A. (ELE.MC) Enel SpA (ENEI.MI)

Fortum (FUM1V.HE) Gas Natural SDG SA (GAS.MC) GDF Suez SA (GSZ.PA)

Iberdrola SA (IBE.MC) International Power Plc (IPR.L) National Grid Plc (NG.L)

Red Electrica Corporacion SA (REE.MC) Redes Energeticas Nacionais (RENE.LS) RWE (RWEG.DE)

Snam Rete Gas SpA (SRG.MI) SSE (SSE.L) Terna SpA (TRN.MI)

Verbund (VERB.VI)

Distribution of Ratings:

Barclays Capital Inc. Equity Research has 1916 companies under coverage.

44% have been assigned a 1-Overweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Buy rating; 56% of companies with this rating are investment banking clients of the Firm.

41% have been assigned a 2-Equal Weight rating which, for purposes of mandatory regulatory disclosures, is classified as a Hold rating; 49% o f companies with this rating are investment banking clients of the Firm.

12% have been assigned a 3-Underweight rating which, for purposes of mandatory regulatory disclosures, is classified as a Sell rating; 35% of companies with this rating are investment banking clients of the Firm.

Guide to the Barclays Capital Price Target:

Each analyst has a single price target on the stocks that they cover. The price target represents that analyst's expectation of where the stock willtrade in the next 12 months. Upside/downside scenarios, where provided, represent potential upside/potential downside to each analyst's pricetarget over the same 12-month period.

Barclays Capital offices involved in the production of equity research:

London

Barclays Capital, the investment banking division of Barclays Bank PLC (Barclays Capital, London)

New York

Barclays Capital Inc. (BCI, New York)

Tokyo

Barclays Capital Japan Limited (BCJL, Tokyo)

São Paulo

Banco Barclays S.A. (BBSA, São Paulo)

Hong Kong

Barclays Bank PLC, Hong Kong branch (Barclays Bank, Hong Kong)




2 November 2011 58


Toronto

Barclays Capital Canada Inc. (BCC, Toronto)

Johannesburg

Absa Capital, a division of Absa Bank Limited (Absa Capital, Johannesburg)

Mexico City

Barclays Bank Mexico, S.A. (BBMX, Mexico City)

Taiwan

Barclays Capital Securities Taiwan Limited (BCSTW, Taiwan)

Seoul

Barclays Capital Securities Limited (BCSL, Seoul)

Mumbai

Barclays Securities (India) Private Limited (BSIPL, Mumbai)

Singapore

Barclays Bank PLC, Singapore branch (Barclays Bank, Singapore)




2 November 2011 59


Centrica (CNA LN / CNA.L) Stock Rating Sector View

GBP 2.97 (31-Oct-2011) 3-UNDERWEIGHT 2-NEUTRAL

Rating and Price Target Chart - GBP (as of 31-Oct-2011) Currency=GBP

Date Closing Price Rating Price Target

18-Jul-2011 3.19 1-Overweight 3.70

10-May-2011 3.09 3.20

Closing Price Target Price Rating Change

Jan-09 Jul- 09 Jan-10 Jul- 10 Jan-11 Jul- 11

2.00

2.25

2.50

2.75

3.00

3.25

3.50

3.75

21-Jun-2010 3.03 3-Underweight 2.95

Link to Barclays Capital Live for interactive charting

Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from Centrica in the past 12 months.

Barclays Bank PLC and/or an affiliate trades regularly in the securities of Centrica.

Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from Centrica within the past 12 months.

Centrica is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

Centrica is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLC and/or anaffiliate.

Valuation Methodology: We value Centrica using a SOTP based on divisional DCF models. We assume a 5.0% long-term BGRE EBIT margin andmarked-to-market commodity prices. We use a post-tax nominal WACC of 7.7%, reflecting Centrica's relatively low gearing. However, givenchallenging market conditions, we believe Centrica is likely to trade at a discount to SOTP. Based on its historic valuation range relative to theStoxx Utilities, we believe Centrica should trade on 9.5x 2013E P/E. This is how we derive our £2.60 price target.

Risks which May Impede the Achievement of the Price Target: The outlook for Centrica's earnings and valuation is dependant on a number of factors, most notable the evolution of energy prices. In the short-term, a fall in wholesale energy prices would improve Centrica's competitiveposition, though in the long-term it would reduce valuation in our view. A more benign regulatory environment would allow Centrica to earn ahigher than expected retail margin. On the downside, growing competition, slowing economic growth or regulatory risk may inhibit futuregrowth both in the UK and US.

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B033F22&legend=Centrica&shortlegend=CNA.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B033F22&legend=Centrica&shortlegend=CNA.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS




2 November 2011 60


Drax Group (DRX LN / DRX.L) Stock Rating Sector View

GBP 5.43 (31-Oct-2011) 1-OVERWEIGHT 2-NEUTRAL



19-Jan-2011 3.95 3-Underweight

25-May-2010 3.26 2-Equal Weight



3.0

3.5

4.0

4.5

5.0

5.5

6.0

6.5

30-Mar-2010 3.80 3-Underweight 3.20


Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from Drax Group in the past 12 months.

Barclays Bank PLC and/or an affiliate trades regularly in the securities of Drax Group.

Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from Drax Group within the past 12 months.

Drax Group is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

Drax Group is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLC and/oran affiliate.

Valuation Methodology: We value Drax based on a DCF valuation model. We assume a 7.6% post-tax WACC and mark our commodity priceassumptions to market. Our central scenario assumes that Drax converts to 50% biomass co-firing by 2015, with biomass costs at 2.2x coal onaverage. However, we also assign a 15% probability to Drax converting to 100% biomass by 2020. In combination, this leads to a £6.75 pricetarget.

Risks which May Impede the Achievement of the Price Target: Drax is a risky stock and several uncertainties remain, which could trigger bothupside and downside risks: 1) future ROC bandings or feed-in tariff support; 2) the level of capex required to convert the plant; 3) technicaluncertainties, including the impact of conversion on thermal efficiency; 4) capital structure; 5) biomass availability and price; 6) the overall levelof power prices. Drax's DCF is highly sensitive to these assumptions.

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B1VNSX3&legend=Drax%20Group&shortlegend=DRX.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B1VNSX3&legend=Drax%20Group&shortlegend=DRX.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS




2 November 2011 61


National Grid Plc (NG/ LN / NG.L) Stock Rating Sector View

GBP 6.18 (31-Oct-2011) 1-OVERWEIGHT 2-NEUTRAL



19-May-2011 6.22 6.80

19-Jan-2011 5.31 6.40

18-Nov-2010 5.88 6.20

15-Nov-2010 5.90 6.15

26-Jul-2010 5.09 5.80



4.75

5.00

5.25

5.50

5.75

6.00

6.25

6.50

6.75

7.00

7.25

7.50

19-Apr-2010 6.49 1-Overweight 6.74


Barclays Bank PLC and/or an affiliate has been lead manager or co-lead manager of a publicly disclosed offer of securities of National Grid Plc inthe previous 12 months.

Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from National Grid Plc in the past 12 months.

Barclays Bank PLC and/or an affiliate expects to receive or intends to seek compensation for investment banking services from National Grid Plcwithin the next 3 months.

Barclays Bank PLC and/or an affiliate beneficially owns 1% or more of any class of common equity securities of National Grid Plc.

Barclays Bank PLC and/or an affiliate trades regularly in the securities of National Grid Plc.

Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from National Grid Plc within the past 12months.

National Grid Plc is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

National Grid Plc is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLCand/or an affiliate.

Valuation Methodology: We value National Grid with a SOTP approach. UK regulated activities are valued with an RAV-adjusted approach, USassets with EV/EBITDA multiples differentiated by businesses and not regulated activities at DCF or multiples as appropriate. Net debt is includedat book value.

Risks which May Impede the Achievement of the Price Target: National Grid financials and valuation are based on current tariffs. A change tothe regulatory framework might affect our estimates.

Other Material Conflicts: Barclays Capital, the Investment Banking Division of Barclays Bank PLC, is acting as corporate broker to National GridPlc.

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B08SNH3&legend=National%20Grid%20Plc&shortlegend=NG.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=B08SNH3&legend=National%20Grid%20Plc&shortlegend=NG.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS




2 November 2011 62


SSE (SSE LN / SSE.L) Stock Rating Sector View

GBP 13.44 (31-Oct-2011) 2-EQUAL WEIGHT 2-NEUTRAL


Closing Price


14

16

18

20

22

24



Barclays Bank PLC and/or an affiliate has been lead manager or co-lead manager of a publicly disclosed offer of securities of SSE in the previous12 months.

Barclays Bank PLC and/or an affiliate has received compensation for investment banking services from SSE in the past 12 months.

Barclays Bank PLC and/or an affiliate beneficially owns 1% or more of any class of common equity securities of SSE.

Barclays Bank PLC and/or an affiliate trades regularly in the securities of SSE.

Barclays Bank PLC and/or an affiliate has received non-investment banking related compensation from SSE within the past 12 months.

SSE is, or during the past 12 months has been, an investment banking client of Barclays Bank PLC and/or an affiliate.

SSE is, or during the past 12 months has been, a non-investment banking client (securities related services) of Barclays Bank PLC and/or anaffiliate.

Valuation Methodology: We value SSE using a SOTP based on divisional DCF models. We assume a 5.0% long-term retail margin and marked-to-market commodity prices. We use a post-tax nominal WACC of 7.0%. However, given challenging market conditions, we believe SSE is likelyto trade at a discount to SOTP. Based on its historic valuation range relative to the Stoxx Utilities, we believe SSE should trade on 9.9x 2013E P/E.This is how we derive our £12.35 price target.

Risks which May Impede the Achievement of the Price Target: SSE's power generation business is exposed to spark spreads, dark spreads andabsolute power prices. These could drive both upside and downside to the shares. SSE's network assets are exposed to UK RPI, and haveupcoming regulatory reviews which could alter returns. SSE's balance sheet is relatiev stretched which could impede future investments. SSE's UKsupply business is at risk should aggressive price competition break out.

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=0790873&legend=SSE&shortlegend=SSE.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS

https://live.barcap.com/go/NYF/flex/equity/EquityChart.jsp?ticker=0790873&legend=SSE&shortlegend=SSE.L&currency=GBP&enddate=20111031&begindate=20101031&userId=bisztygp&appName=RPS



DISCLAIMER:

This publication has been prepared by Barclays Capital, the investment banking division of Barclays Bank PLC, and/or one or more of its affiliates as provided below. It isprovided to our clients for information purposes only, and Barclays Capital makes no express or implied warranties, and expressly disclaims all warranties omerchantability or fitness for a particular purpose or use with respect to any data included in this publication. Barclays Capital will not treat unauthorized recipients ofthis report as its clients. Prices shown are indicative and Barclays Capital is not offering to buy or sell or soliciting offers to buy or sell any financial instrument.

Without limiting any of the foregoing and to the extent permitted by law, in no event shall Barclays Capital, nor any affiliate, nor any of their respective officers, directors,partners, or employees have any liability for (a) any special, punitive, indirect, or consequential damages; or (b) any lost profits, lost revenue, loss of anticipated savings

or loss of opportunity or other financial loss, even if notified of the possibility of such damages, arising from any use of this publication or its contents.Other than disclosures relating to Barclays Capital, the information contained in this publication has been obtained from sources that Barclays Capital believes to bereliable, but Barclays Capital does not represent or warrant that it is accurate or complete. The views in this publication are those of Barclays Capital and are subject tochange, and Barclays Capital has no obligation to update its opinions or the information in this publication.

The analyst recommendations in this publication reflect solely and exclusively those of the author(s), and such opinions were prepared independently of any otherinterests, including those of Barclays Capital and/or its affiliates. This publication does not constitute personal investment advice or take into account the individualfinancial circumstances or objectives of the clients who receive it. The securities discussed herein may not be suitable for all investors. Barclays Capital recommends thainvestors independently evaluate each issuer, security or instrument discussed herein and consult any independent advisors they believe necessary. The value of andincome from any investment may fluctuate from day to day as a result of changes in relevant economic markets (including changes in market liquidity). Theinformation herein is not intended to predict actual results, which may differ substantially from those reflected. Past performance is not necessarily indicative of futureresults.

This communication is being made available in the UK and Europe primarily to persons who are investment professionals as that term is defined in Article 19 of theFinancial Services and Markets Act 2000 (Financial Promotion Order) 2005. It is directed at, and therefore should only be relied upon by, persons who have professionalexperience in matters relating to investments. The investments to which it relates are available only to such persons and will be entered into only with such personsBarclays Capital is authorized and regulated by the Financial Services Authority ('FSA') and member of the London Stock Exchange.

Barclays Capital Inc., U.S. registered broker/dealer and member of FINRA (www.finra.org), is distributing this material in the United States and, in connection therewithaccepts responsibility for its contents. Any U.S. person wishing to effect a transaction in any security discussed herein should do so only by contacting a representativeof Barclays Capital Inc. in the U.S. at 745 Seventh Avenue, New York, New York 10019.

Non-U.S. persons should contact and execute transactions through a Barclays Bank PLC branch or affiliate in their home jurisdiction unless local regulations permiotherwise.

This material is distributed in Canada by Barclays Capital Canada Inc., a registered investment dealer and member of IIROC (www.iiroc.ca). To access Barclays Capitalpolicy on the dissemination of research reports, please go to http://www.barcap.com/Client+offering/Research/Research+Policy.

Subject to the conditions of this publication as set out above, Absa Capital, the Investment Banking Division of Absa Bank Limited, an authorised financial servicesprovider (Registration No.: 1986/004794/06), is distributing this material in South Africa. Absa Bank Limited is regulated by the South African Reserve Bank. Thipublication is not, nor is it intended to be, advice as defined and/or contemplated in the (South African) Financial Advisory and Intermediary Services Act, 37 of 2002, oany other financial, investment, trading, tax, legal, accounting, retirement, actuarial or other professional advice or service whatsoever. Any South African person oentity wishing to effect a transaction in any security discussed herein should do so only by contacting a representative of Absa Capital in South Africa, 15 Alice LaneSandton, Johannesburg, Gauteng 2196. Absa Capital is an affiliate of Barclays Capital.

In Japan, foreign exchange research reports are prepared and distributed by Barclays Bank PLC Tokyo Branch. Other research reports are distributed to institutiona

investors in Japan by Barclays Capital Japan Limited. Barclays Capital Japan Limited is a joint-stock company incorporated in Japan with registered office of 6-10-1Roppongi, Minato-ku, Tokyo 106-6131, Japan. It is a subsidiary of Barclays Bank PLC and a registered financial instruments firm regulated by the Financial ServicesAgency of Japan. Registered Number: Kanto Zaimukyokucho (kinsho) No. 143.

Barclays Bank PLC, Hong Kong Branch is distributing this material in Hong Kong as an authorised institution regulated by the Hong Kong Monetary AuthorityRegistered Office: 41/F, Cheung Kong Center, 2 Queen's Road Central, Hong Kong.

This material is issued in Taiwan by Barclays Capital Securities Taiwan Limited. This material on securities not traded in Taiwan is not to be construed as'recommendation' in Taiwan. Barclays Capital Securities Taiwan Limited does not accept orders from clients to trade in such securities. This material may not bedistributed to the public media or used by the public media without prior written consent of Barclays Capital.

This material is distributed in South Korea by Barclays Capital Securities Limited, Seoul Branch.

All equity research material is distributed in India by Barclays Securities (India) Private Limited (SEBI Registration No: INB/INF 231292732 (NSE), INB/INF 011292738(BSE), Registered Office: 208 | Ceejay House | Dr. Annie Besant Road | Shivsagar Estate | Worli | Mumbai - 400 018 | India, Phone: + 91 22 67196363). Other researchreports are distributed in India by Barclays Bank PLC, India Branch.

Barclays Bank PLC Frankfurt Branch distributes this material in Germany under the supervision of Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin).

This material is distributed in Malaysia by Barclays Capital Markets Malaysia Sdn Bhd.

This material is distributed in Brazil by Banco Barclays S.A.

This material is distributed in Mexico by Barclays Bank Mexico, S.A.

Barclays Bank PLC in the Dubai International Financial Centre (Registered No. 0060) is regulated by the Dubai Financial Services Authority (DFSA). Barclays Bank PLCDIFC Branch, may only undertake the financial services activities that fall within the scope of its existing DFSA licence.

Barclays Bank PLC in the UAE is regulated by the Central Bank of the UAE and is licensed to conduct business activities as a branch of a commercial bank incorporatedoutside the UAE in Dubai (Licence No.: 13/1844/2008, Registered Office: Building No. 6, Burj Dubai Business Hub, Sheikh Zayed Road, Dubai City) and Abu Dhabi(Licence No.: 13/952/2008, Registered Office: Al Jazira Towers, Hamdan Street, PO Box 2734, Abu Dhabi).

Barclays Bank PLC in the Qatar Financial Centre (Registered No. 00018) is authorised by the Qatar Financial Centre Regulatory Authority (QFCRA). Barclays Bank PLC-QFC Branch may only undertake the regulated activities that fall within the scope of its existing QFCRA licence. Principal place of business in Qatar: Qatar FinanciaCentre, Office 1002, 10th Floor, QFC Tower, Diplomatic Area, West Bay, PO Box 15891, Doha, Qatar.

This material is distributed in Dubai, the UAE and Qatar by Barclays Bank PLC. Related financial products or services are only available to Professional Clients as definedby the DFSA, and Business Customers as defined by the QFCRA.



This material is distributed in Saudi Arabia by Barclays Saudi Arabia ('BSA'). It is not the intention of the Publication to be used or deemed as recommendation, option oradvice for any action (s) that may take place in future. Barclays Saudi Arabia is a Closed Joint Stock Company, (CMA License No. 09141-37). Registered office AFaisaliah Tower | Level 18 | Riyadh 11311 | Kingdom of Saudi Arabia. Authorised and regulated by the Capital Market Authority, Commercial Registration Number1010283024.

This material is distributed in Russia by OOO Barclays Capital, affiliated company of Barclays Bank PLC, registered and regulated in Russia by the FSFM. Broker Licens#177-11850-100000; Dealer License #177-11855-010000. Registered address in Russia: 125047 Moscow, 1st Tverskaya-Yamskaya str. 21.

This material is distributed in Singapore by the Singapore branch of Barclays Bank PLC, a bank licensed in Singapore by the Monetary Authority of Singapore. Fo

matters in connection with this report, recipients in Singapore may contact the Singapore branch of Barclays Bank PLC, whose registered address is One Raffles QuayLevel 28, South Tower, Singapore 048583.

Barclays Bank PLC, Australia Branch (ARBN 062 449 585, AFSL 246617) is distributing this material in Australia. It is directed at 'wholesale clients' as defined byAustralian Corporations Act 2001.

IRS Circular 230 Prepared Materials Disclaimer: Barclays Capital and its affiliates do not provide tax advice and nothing contained herein should be construed to be taxadvice. Please be advised that any discussion of U.S. tax matters contained herein (including any attachments) (i) is not intended or written to be used, and cannot beused, by you for the purpose of avoiding U.S. tax-related penalties; and (ii) was written to support the promotion or marketing of the transactions or other matteraddressed herein. Accordingly, you should seek advice based on your particular circumstances from an independent tax advisor.

Barclays Capital is not responsible for, and makes no warranties whatsoever as to, the content of any third-party web site accessed via a hyperlink in this publication andsuch information is not incorporated by reference.

© Copyright Barclays Bank PLC (2011). All rights reserved. No part of this publication may be reproduced in any manner without the prior written permission of BarclaysCapital or any of its affiliates. Barclays Bank PLC is registered in England No. 1026167. Registered office 1 Churchill Place, London, E14 5HP. Additional informationregarding this publication will be furnished upon request.

barcap - uk big 6 utilities - 20111102

Documents