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Portfolio Construction Techniques: A Brief Review

Summary The mean-variance optimization suggested by Henry Markowitz represents a path-breaking work, the beginning of the so-called Modern Portfolio Theory. This theory has been criticized by some researchers for issues linked to parameter uncertainty. Two main approaches to the problem may be identified: a non-Bayesian and a Bayesian approach. Smart Beta strategies are virtually placed between pure alpha strategies and beta strategies and emphasize capturing investment factors in a transparent way. The article does not determine which strategy is the best, since I believe that the success of an investment technique cannot be determined a priori. Introduction How to allocate capital across different asset classes is a key decision that all investors are required to make. It is widely accepted that holding one or few assets is not advisable, as the proverb “Don’t put all your eggs in one basket” suggests. Hence, practitioners recommend their clients to build portfolios of assets in order to benefit from the effects of diversification. An investor’s portfolio is defined as his/her collection of investment assets. Generally, investors make two types of decisions in constructing portfolios. The first one is called asset allocation, namely the choice among different asset classes. The second one is defined security selection, namely the choice of which particular securities to hold within each asset class. Moreover, portfolio construction could follow two kinds of approaches, namely a top-down or a bottom-up approach. The former consists in facing the asset allocation and security selection choices exactly in this order. The latter inverts the flow of actions, starting from security selection. No matter the kind of approach, investors do need a precise rule to follow when building a portfolio. In fact, the choice of asset classes and/or of securities has to be done rationally. The range of existing strategies is considerably wide. Indeed, one may allocate his/her own capital by splitting it equally among assets, optimizing several functions and/or applying some constraints. Every day in the asset management industry, there are plenty of strategies that are proposed to investors all over the world. The aim of this article is to provide the reader with a comprehensive summary of those. Static and Dynamic Optimization Techniques To begin with, it is worth distinguishing the existing portfolio optimization techniques by the nature of their optimization process. In particular, static and dynamic processes are considered. In the former case, the structure of a portfolio is chosen once for all at the beginning of the period. In the latter case, the structure of the portfolio is continuously adjusted (for a detailed survey on this literature, see Mossin (1968), Samuelson (1969), Merton (1969, 1971), Campbell et al (2003), Campbell & Viceira (2002). Maillard (2011) reports that for highly risk-averse investors, the difference between the two is moderate, whereas it is larger for investors who are less risk averse. Markowitz Mean-Variance Optimization Within the static models, it is common knowledge that the mean-variance optimization suggested by Henry Markowitz represents a path-breaking work, the beginning of so-called Modern Portfolio Theory (MPT). In fact, Markowitz ( 1952 , 1959 ) presents a revolutionary framework based on the mean and variance of a portfolio of “N” assets. In particular, he claims that if investors care only about mean and variance, they would hold the same portfolio of risky assets, combined with cash holdings, whose proportion depends on their risk aversion. Despite of its wide success, this theory has been criticized by some researchers for issues linked to parameter uncertainty. In fact, the true model parameters are unknown and have to be estimated from the data, resulting in several estimation error problems. The subsequent literature has focused on improving the mean-variance framework in several ways. However, two main approaches to the problem may be identified, namely a non-Bayesian and a Bayesian approach. Two Approaches As far as the former is concerned, it is worth reporting several studies. For instance, Goldfarb & Iyengar (2003) and Garlappi et al. (2007) provide robust formulations to contrast the sensitivity of the optimal portfolio to statistical and modelling errors in the estimates of the relevant parameters. In addition, Lee (1977) and Kraus & Litzenberger (1976) present alternative portfolio theories that include more moments such as skewness; Fama (1965) and Elton & Gruber (1974) are more accurate in describing the distribution of return, while Best & Grauer (1992), Chan et al. (1999) and Ledoit & Wolf (2004a, 2004b) focus on methods that aim to reduce the estimation error of the covariance matrix. Other approaches involve the application of some constraints. MacKinlay & Pastor (2000) impose constraints on moments of assets returns, Jagannathan & Ma (2003) adopt short-sale constraints, Chekhlov et al (2000) drawdown constraints, Jorion (2002) tracking-error constraints, while Chopra (1993) and Frost & Savarino (1988) propose constrained portfolio weights. On the other hand, the Bayesian approach plays a prominent role in the literature. It is based on Stein (1955) , who proved the inadmissibility of the sample mean as an estimator for multivariate portfolio problems. In fact, he advises to apply the Bayesian shrinkage estimator that minimizes the errors in the return expectations, rather than trying to minimize the errors in each asset class return expectation separately. In following studies, this approach has been implemented in multiple ways. Barry (1974) and Bawa et al (1979) use either a non-informative diffuse prior or a predictive distribution obtained by integrating over the unknown parameter. Then, Jobson & Korkie (1980), Jorion (1985, 1986) and Frost & Savarino (1986) use empirical Bayes estimators, which shrink estimated returns closer to a common value and move the portfolio weights closer to the global minimum-variance portfolio. Finally, Pastor (2000), and Pastor & Stambaugh (2000) use the equilibrium implications of an asset-pricing model to establish a prior. Simpler Models To attempt portfolio construction throughout optimization is not the only alternative, though. In fact, alongside the wide range of portfolio optimization techniques, it is also worth considering other rules that require no estimation of parameters and no optimization at all. DeMiguel at al (2005) define them as ” simple asset-allocation rules “. For instance, one could just allocate all the wealth in a single asset, i.e., the market portfolio . Alternatively, investors may adopt the 1/N rule, dividing their wealth according to an equal-weighting scheme. At this point, the reader may wonder why one should consider this kind of rules. In fact, techniques that require no optimization should not be optimal according to any measure. However, as far as the naïve 1/N is concerned, some researchers have reported some interesting results. For instance, Benartzi & Thaler (2001) and Liang & Weisbenner (2002) show that more than a third of direct contribution plan participants allocate their assets equally among investment options, obtaining good returns. Moreover, Huberman & Jiang (2006) find similar results. Similarly, DeMiguel et al (2009) evaluate 14 models across seven empirical datasets, finding that none is consistently better than the 1/N rule in terms of Sharpe ratio, certainty-equivalent return or turnover. However, Tu & Zhou (2011) challenge DeMiguel et al. (2009) combining sophisticated optimization approaches with the naïve 1/N technique. Their findings confirm that the combined rules have a significant impact in improving the sophisticated strategies and in outperforming the simple 1/N rule. Moreover, other naïve rules are reported by Chow et al. (2013), such as the 1/σ and the 1/β, included in the so-called low-volatility investing methods. In particular, they report that low-volatility investing provides higher returns at lower risk than traditional cap-weighted indexing, at the cost of underperformance in upward-trending environments. Smart Beta Strategies Finally, it is worth mentioning a special group of strategies that are extremely popular among asset management firms, known as Smart Beta strategies. Smart Beta strategies are virtually placed between pure alpha strategies and beta strategies, and emphasise capturing investment factors in a transparent way, such as value, size, quality and momentum. Examples of these strategies are risk parity, minimum volatility, maximum diversification and many others. Apart from the wide range of these kinds of techniques, it is critical to highlight why they are so diffuse among practitioners. Their enormous success is due to several interesting advantages, including the flexibility to access tailored market exposures, improved control of portfolio exposures and the potential to achieve improved return/risk trade-offs. Final Remarks This article aims to be a summary of the most notorious techniques considered in the existing literature, but the list is far from being complete. Moreover, the article does not analyze which strategy is the best, since I believe that the success of an investment technique depends on several factors, including the time frame considered, the kind of assets, the geography of the examined portfolio, the client’s preferences, and it surely must rely on a quantitative application using real or simulated data.

E.ON (ENAKF) Q3 2015 Results – Earnings Call Transcript

Executives Anke Groth – Head of Investor Relations Michael Sen – Chief Financial Officer Analysts Lawson Steele – Berenberg Bank Vincent Gilles – Credit Suisse Bobby Chada – Morgan Stanley Nathalie Casali – J.P. Morgan Andreas Thielen – MainFirst Bank AG Peter Bisztyga – Bank of America Merrill Lynch Alberto Ponti – Société Générale Deepa Venkateswaran – Bernstein Global Wealth Management E.ON SE ( OTCQX:ENAKF ) Q3 2015 Earnings Conference Call November 11, 2015 5:00 AM ET Operator Dear, ladies and gentlemen, welcome to the E.ON Nine Months Results Conference Call. At our customer’s request, this conference will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions] May I now hand you over to Mrs. Anke Groth, who will lead you through this conference. Please go ahead, Madam. Anke Groth Thank you. Dear analysts and investors, good morning, and welcome also from my side. Michael Sen, our CFO, will not only talk about the details of our results, but will also touch upon relevant events since we spoke to you last time. We suggest to close the call 10 minutes before 11:00 AM UK time, to leave sufficient time for those of you honoring the Armistice Day. Therefore, we also propose a limited number of two questions for every active participant. All remaining questions can be directed to the IR team after the call. But first, over to you, Michael. Michael Sen Thank you, Anke. A warm welcome also from my side to our nine months results presentation. I guess, we can all concur that Q3 calendar 2015 has been quite an eventful quarter for all – with all the discussions around the draft of nuclear liability law and the stress test of nuclear provisions. Consequently, we had quite a busy quarter, not only executing on our spin, but also adapting the transaction structure, furthermore focusing our portfolio and closing our books incorporating the already-announced impairment. To get us started, let me first give you a snapshot of the nine-month results. Financially, we came in pretty much in line with expectation. We continue to see no support from the economic and regulatory environment. Hence, also this quarter had its challenges. Wholesale power prices in our markets prolonged their negative price trends. So did oil and gas prices, which have stayed low, oil below $50 per barrel and gas around €17 per megawatt hour. FX also, in part, had its adverse effects, namely the ruble which was at RUB67 per euro. In terms of earnings, EBITDA contracted by €1.2 billion or 18% in the first nine months versus prior year, while underlying net income benefited below the line in absolute terms hence being down €400 million year over year. Bottom-line earnings per share also declined by €0.22 a share. Operating cash flow down 23% against prior year, yet, came in strong with a cash conversion rate of 107%. Looking at the balance sheet, the economic net debt reduced nicely by €5.3 billion compared to year-end levels of 2014. In Q3, we had to book one-off charges of €8.3 billion. This represents the lion’s share of the already flagged impairment. By this we have depreciated all of the goodwill within the segment generation. Adding to this, we have also impaired assets in that segment in the area of €1.6 billion. Hence, the segment generation accounts for 70% of the total figure. The second largest impact was in the E&P segment, where €1.6 billion of the impairment took place. Of the total €8.3 billion figure, goodwill accounts for around €5.3 billion, roughly 65%. On the operational and business development side, there was good progress. The spinoff is right on track. Uniper is now a stand-alone legal entity and we’ve completed the transfer of several businesses. Up until now, all milestones have been reached as planned. Currently, we’re working flat out on the information most relevant to you guys, i.e., we focus on the combined financials in order to be ready around March next year. Besides that, we kicked off the draft for the prospectus, as well as the equity stories for both companies. Latter will be provided at the Capital Markets Day scheduled early May including comprehensive information on future E.ON and Uniper. Coming back to current business developments, there are a lot of good things happening. Our offshore wind parks, Humber Gateway and Amrumbank, are fully operational; so is our lignite power plant, Berezovskaya in Russia, finally. We have further focused our portfolio on the core and agreed on selling our E& P activities in Norway for a, what we deem, attractive price. In the Renewables space, we have also found another partner taking a 24.9% participation in our next offshore wind park project, Rampion. All-in-all, a decent quarter, as expected and solid nine months. As a result, we are confirming – reconfirming, our expectations for 2015. Coming to Chart 2, as you know on October 10 the independent stress test report on E.ON’s nuclear provisions was released. Despite a lot of unnecessary and unfounded speculation the report very much confirmed what we knew. Basically, the outside auditor reported that our provision estimates and cost estimates are adequate and properly calculated; and more important, accounted for. This has been a key critical milestone. Another crucial finding was that the asset side is sufficient to cover the liabilities, also for the scenarios covered by the audit report. Equally important, the German Economic Minister stated that he considers the German utilities provision to be within the appropriate range. We’ve said, all along, that our estimates were based on very stringent and transparent assumptions. The discount rate and cost estimates i.e., E.ON’s real discount rate of about 4.7% is pretty well in line compared to other geographies and other companies. One might even say it is conservative. So let me summarize. Our nuclear profit provisions are fully appropriate and correct. This is also confirmed by the report. Our cost estimates are realistically and prudently calculated. This stress test has been handed over to the newly formed Government Commission. Hence, it will now form one data point – one single data point, which flows into the work of the nuclear commission. We understand that the commission shall give its recommendations to the government by February next year. We look forward to an open and constructive dialog on this topic as we move along. Now, let’s look into the details of the nine months EBITDA on Chart 3. As indicated earlier, €5.4 billion, the number is roughly in line with the indicated full-year trends. There are few timing effects or reclassifications from prior-year period. For example, these numbers are based on a pro-forma adjusted 2014 basis. Meantime, we decided not to sell our regional unit Italy, resulting in a reclassification of discontinued operations, which now only reflects the disposal of regional unit Spain, and hence, affect the 2014 first nine months by €100 million. We also transferred a wholesale business from regional unit Germany into global commodities, resulting in a €50 million change to both businesses. I guess as expected, the biggest items on EBITDA year-over-year were the power price decline and the volume effect. Pricing weakness accounts for more than half the figure, with prices for the outright power generated in Central Europe as well as the Nordic markets, down €6 per megawatt hour. Decreased volumes in our nuclear generations are due to lower production from Ringhals 2 in Sweden, as well as the shutdown of Grafenrheinfeld in Germany. This was only partly compensated by higher volumes from Swedish hydro. No surprise that weak oil and gas prices hit our E&P operations, as did the Yuzhno-Russkoye gas field developments. We got some tailwind from currency changes in UK or the UK pound and the US dollar. If it comes to volume for the full year, we expect it to be roughly about the neighborhood of what we’ve seen in 2014. The €300 million disposal effect is mainly related to the disposal of our Spanish and Italian generation and renewables activities, also including lower earnings in generation Italy for the first half, when the business was still consolidated. In the underlying, you may recall that global commodities was mentioned here as a factor providing support mainly driven by gas optimization. As we’ve actually seen a rather weak Q3 compared to 2014, this has come off the initial €100 million positive effect mentioned by us at earlier stages. Adding to this there is by now a sizable negative intra-year effect, which has accumulated with regards to our CO2 hedging. This effect is actually relating back to a strong earnings swing during 2014. As you know the financial settlement of our CO2 hedges happened in one go in December. In the course of 2014, the intra-year earnings of global commodity were strongly benefiting from low CO2 spot prices compared to our hedges. This then, turned around in the isolated Q4 2014 with December hedge settlement. In a way, we had an unusual strong nine months in calendar 2014, which then evened out in Q4 calendar 2014. This year the differential between the CO2 spot price and the average price of our hedges is not significant, so that last year’s development is not repeated and year-over-year, we see a large negative delta of €200 million in the first nine months, which will then unwind in Q4. In other words, I expect global commodities to have a very strong Q4. In our non-EU segment, we’ve seen improvement in our Turkish operation in Enerjisa, this was more than offset by lower earnings from Russia, driven by the ruble weakness and other events at Surgutskaya and Berezovskaya sites. All in all, this segment was down €200 million, versus Q3 last year. We also saw lower earnings in our group management consolidation line, driven by several effects of largely one-off character. On the plus side we commissioned major sites during Q3. Amrumbank and Humber are fully producing. Maasvlakte is also running in a stable manner. In total, the positive contribution of new capacities for the first nine months has amounted to around €100 million. Berezovskaya has passed its most critical 72 hour test and is now receiving its capacity payment. The additional earnings contribution will be seen in Q4. Earnings in Germany have expanded nicely, in line with our full year guidance, driven by better gross margin in the non-regulated business and benefitting from positive weather effect for the first two quarters. Noteworthy, cost reduction measures have been ramping up again, after taking a breath in the first half. You will see more by year-end, as we are aiming to show you a positive net cost reduction of €100 million. Moving further down the P&L into underlying net income, you see the interplay between our EBITDA number and underlying net income, as I mentioned earlier. The €1.2 billion contraction in EBITDA did not drop through entirely, and was buffered by the items below the line. Again, as a reminder, all numbers on this chart reflect the pro forma adjustment for the discontinued operations in Spain. For the underlying net income, the pro forma adjustment amounted to €46 million. Depreciation came down by almost €250 million, driven by our disposals. These were comprised of assets in Italy held for sale, and this deconsolidation effect for those Spanish and Italian assets, which have already been sold. The second driver was our large impairment from last year. For the full year, we expect depreciation to come down significantly, roughly in line what we guided at the start of this year. The effects in forcing the drop are the disposal group treatment, the accounting treatment, of the Norwegian E&P assets and this year’s large impairment. Economic interest expense improved by €128 million to €1.1 billion, yet hardly any movement in the isolated Q3. Key component of this improvement, as we have mentioned at the first half, is an increase of discount rates for the other long term provisions in the second quarter. I had alluded to this already, when we had the half year reporting. Our tax rate has increased compared to the half year reporting stage, now at around 34%, up from 27%. We all need to understand the nature of this, this is important. As you know, we use our current full year tax rate expectation as best proxy for the tax rate at the reporting stage. So what has changed in our estimate, compared to when we reported H1 results? We now are expecting an impairment of tax assets in the fourth quarter. This impairment is tied to a revaluation of deferred tax assets and primarily, driven by the revised projections related to the restructurings under 122 [ph]. In light of this, we don’t see this effect as recurrent in nature. And basically, the assumption going forward is that we still have an underlying tax rate of 25% to 30% also in the medium term. The non-controlling interests are in line with our expectation for the full year, slightly lower. Now let’s move from book earnings to cash earnings. On chart 5, we showed the development of the operating cash flow, reconciled from EBITDA, essentially a cash conversion chart, where we add back all non-cash elements. During the reporting period, these amounted to €1.5 billion. €1.7 billion, i.e. over 100% of this figure is related to provision buildup. It is over 100%, because we also adjust for items that are positively impacting EBITDA, but are non-cash. Examples for this would be equity results for participations, where we do not receive a dividend for book gains booked in EBITDA. Obviously, the most prominent elements in this provision are provisions for CO2 needed for our fossil fleet, provisions for renewable obligation certificates, pension provisions, personnel provisions, and others. As the majority of these provisions are related to our normal course of business and are somewhat recurrent in nature, they are subject to regular utilization and, therefore, cash out. For the first nine months this provision utilization amounted to €2.3 billion. The key factor explaining the large difference between the provision utilization and the provision buildup is the nuclear phase out. With regards to German nuclear we are by now adding only minor amount of provisions via the EBITDA line, every year, related to additional spend on fuel rods, but are actually already utilizing them to quite some extent. The figure, which we have been announcing when we were elaborating on the change of transaction structure, roughly €500 million to €600 million. The €1.5 billion net positive effect resulting from working capital movement is mainly driven by our two regional units, Germany and UK. In these cases, there are strong seasonalities, for which we will see partially compensating effects in the fourth quarter, i.e., I do expect a significant buildup of receivables in the regional entities for year-end. It is our view that the still high cash conversion of the first nine months, of 107% will convert to a more normal figure for the full year, based as I said, mainly on the seasonality in our business, and expected changes in working capital. Taking this into account, we expect to land in the upper part of our normal range for the cash conversion of 60% to 70% for the full year. In terms of balance sheet quality, the economic net debt continued to shrink during the third quarter. A strong cash balance, divestments and lower pension provision have driven our economic net debt down by €5.3 billion, compared to year-end 2014 level. Here are the main elements driving this development. In light of the cash conversion performance, our cash balance is still €2.3 billion and very strong, even though two-thirds of the planned full-year CapEx have by now been spent. The nine months operating cash flow of €5.7 billion has hence largely exceeded the CapEx and the dividend spend. Just to remind you, €900 million of dividend comprises our own dividend payment for the fixed €0.50 per share, adjusted for the 37% scrip pickup, plus, the dividend payment to minority shareholders such as our shareholders in E.ON Russia. Our CapEx has now reached €2.7 billion with the third quarter contributing over a fourth of the planned full-year budget. This still leaves us with around €1.5 billion to be spent in the fourth quarter, which is in line with normal seasonality, because, as you know, we tend to have CapEx more geared to the second half of the year. Our future E.ON businesses were responsible for 70% of this CapEx spend. Uniper businesses account for €600 million. This still includes CapEx for two major large generation projects, which are being finalized this year, Maasvlakte and Berezovskaya. The €2.4 billion of divestments are basically unchanged since our H1 reporting, and are mainly attributable to our disposal of the Spanish activities, as well as the Italian solar business. The bulk of the remainder is related to the sale of our remaining stake in E.ON energy from waste. The pension obligation came down by €1 billion, compared to year-end 2014. While the CTA funding has obviously helped, the lion’s share of this improvement can be attributed to the application of a higher discount rate for the German provision, 60 base points, due to higher benchmark bond yields. We have seen an improvement in the others position compared to the half-year status. This is largely related to the disposal of North Sea E&P and the reduction in asset retirement obligation attached to this. Beyond that, the other position still comprises a list of smaller effects such as, for example, changes in shareholder loans and several FX effects. But it also includes €400 million of CTA funding. For the remainder of 2015, there are three important things to observe. Yes, EBITDA-wise Q4 tends to be somewhat stronger, a stronger quarter, but the cash conversion rate will be materially lower for the fourth quarter mainly based on working capital buildup, as I already mentioned. We are expecting a meaningful cash outflow, which potentially could slip into next year as well. Also Q4 is pretty heavy when we talk about spending on CapEx. Taken together, these two would probably result in a negative cash balance in the fourth quarter. So assuming nothing big happens on the provision side of things, with the current low interest environment, there could logically also be somewhat downward pressure on the nuclear discount rate, when we close our accounts year-end. Cash in from disposals, obviously, will play a big role in the fourth quarter and will have their impact on the economic net debt. Here we expect the cash in from E&P and the Italian hydro disposals, both sales expected to close around year-end. With the nine months behind us, we are confirming our outlook ranges for EBITDA at €7 billion to €7.6 billion; and underlying net income at €1.4 billion to €1.8 billion. We are comfortable with these ranges, which take into account some risks, for example, the slight COD delay of our Berezovskaya plant, as well as the continued volatility in commodity and currency markets. All-in-all, a somewhat decent quarter, mainly on the things we can control. Wind projects have come on stream. Our nuclear provisions have passed the stress test, and the transaction is moving forward full steam. Let me conclude on a personal note. By now, I have met and spoken with many of you. As we move further along on E.ON’s timeline, I’m looking forward to being even more active and engage with investors on equity and debt side. Let me hand it over to Anke now, and then we are available for questions. Anke Groth Thank you very much, Michael. Yes, let’s open the Q&A session. And as I said before, please limit yourself to two questions. Question-and-Answer Session Operator We will now begin our question-and-answer session. [Operator Instructions] One moment, please, for the first question. The first question comes from the line of Lawson Steele of Berenberg. Please go ahead, sir. Lawson Steele Yes, thank you. Good morning, everybody. Two questions, obviously first of all, could you walk us through how you think about the dividend of E.ON rump? You’ve been obviously very clear on Uniper that it will be set – based on cash flow rather than earnings. But on the E.ON rump, could you give me a sense of what time period you take into account when setting the dividends? So in other words, do you look at the balance sheet, cash flow and earnings progression over the next three to five years or so, or do you think even longer term, taking into account, for example, the nuclear disbursements over the next 20 to 30 years, say? And secondly, I’m just interested in how you were thinking about the splits. Obviously, originally you were designed to have a stable business on the one side under the heading of E.ON rump and a commodity exposed business in the shape of Uniper. Now, of course, you had to introduce the German nuclear back into E.ON rump, so you’re going to have a commodity exposure there, which wasn’t originally envisaged as well as the provision of uncertainties – provision on uncertainties which go with it. Did you at that point consider stopping the split process, or did you feel that you simply couldn’t, because you had built up so much momentum? Or is it that these two feel there is a significant fundamental difference between the two companies? Maybe you could just elaborate a bit on that. Thank you. Michael Sen Well, thank you for the first question. Well, on the dividend, I guess, as we mentioned, we talk about the dividend when we cross the bridge, and this is obviously for next year. As in policy, you are right, as in positioning. Uniper obviously will be highly geared towards high payouts based more on some sort of a free cash flow number. For E.ON, we will come back to you when we disclose the equity story. It would be premature to already give you too many hints on that one as we are still working on things. The split as such makes all the sense of the world, because we believe that two energy worlds are converging. And the split has never been initiated to get rid of nuclear or something like that. Basically, as you said there is one very big thermal central generation commodity-exposed business. And then there’s another business which has, as you said, stable regulatory asset base, but concurrently also a renewables asset base and growing, in the future more important customer solutions space. So this is a portfolio, which needs to be balanced and which needs to be managed, and then obviously yielding in sufficient returns in order to allocate capital. So the spin is intact. We never thought of calling off the spin, because that would in turn mean that we don’t believe in the fundamentals of the industry any more, that two energy worlds would converge. Now, I think we elaborated last time and during the last couple of months, what was the nature of changing the transaction structure and keeping the German nuclear at E.ON, because other than that we would not have been able to pursue our strategy. Yet, I also gave the market some feelings, what it means near and medium term in terms of net income and in terms of cash flow that in essence it has almost no effect. It just makes the balance sheet longer. Lawson Steele Okay. Thank you. Can I just come back to the first question? And, I appreciate obviously your sort of don’t want to give too much way. But I’m just interested to know how you think about the dividend. Do you think about it in terms of the next five years or do you think about it in the next 20 years, say? Michael Sen I would probably not go that far to say I would think about the next 20 years. I would think about medium term, short and medium term. Usually short term is when you think about next year and that is highly dependable on what you earn. So we first of all have to see whatever we have in our books at that point in time. Medium term is, obviously, more about what are the guidelines, the framing conditions, and this is also the period where we would have our considerations. How do we position E.ON going forward, new E.ON, in terms of dividend? I mean, obviously, there will be dividend, but what will be the level of the payouts and what will be the level of reinvestment. Lawson Steele Okay, thank you very much. Operator The next question comes from Vincent Gilles of Credit Suisse. Please go ahead, sir. Vincent Gilles Yes, good morning, everyone. Question on impairment, could you help us with the assumptions that you’re using for these impairment tests? Obviously, I’m referring to future power prices, commodity prices. I know it’s very complex, but if you could give us a feeling for what you had in mind, what your people had in mind when they did the work. And incidentally, is there anything for Ringhals in this impairment? And the second question is very simple. You gave us a range for the tax rate for the year. Could you be a bit narrow in the range? Can you help us a bit more with the tax rate? Michael Sen Yes, I think the tax rate now is the tax rate which we reported now, because the logic with which we imply the tax rate is that we already anticipate, if you so wish the full year tax rate and then apply it to the quarter. So that would be the full year tax rate, which we have. Now, going forward, I said underlying as a normalized sort of tax rate, if you don’t have one-offs and this clearly is a one-off. It’s not a structural topic, this is a one-off, because of the one to two transactions, where things had been moving from left to right and deferred tax assets had been popping up, which had to be impaired again. So, on an underlying basis I still assume the 25% to 30%. I would have a hard time to narrow that one down, because it’s highly dependent on many, many other items. So – now, on the impairment, as you know – on the impairment, as you know, that this is driven by really long term – this has nothing to do with what we see in forward curves, right. Forward curves you see in liquid markets, you see on your screen. This is about long term projections, which are then applied on testing the recoverability on long-lived assets. Now, to give you a hint, because I can’t walk you through now on every commodity item and which price we now assume in 2025 or 2027, which by the way, I don’t have at the top of my head, but we had or did also backtest this one to all the studies out there, all reputable studies. So there with many studies like [CERA, Perie] [ph] and many, many, many others. So if you take all of them and take their projections, we are, so to say, in the midst of their projections. So this gives you a flavor, a little bit, if you can get hold of these studies. In terms of Ringhals, the negotiation as we talk is ongoing and, therefore, closing for Q3 happened a couple of weeks ago, days ago actually, right? So there’s nothing for Ringhals in the impairment I have been alluding to with the €8.3 billion. But if you heard me say that this is the lion’s share of what we flagged earlier, when we talked about the high single-digit amount. So out of technical reasons are the things we could not eventually – because the business reason wasn’t material enough. There will be another spillover of roughly €500 million in Q4 in terms of impairment. Vincent Gilles Thank you very much. Operator The next question comes from the line of Bobby Chada of Morgan Stanley. Please go ahead. Bobby Chada Thank you. Two questions, so the first is, Michael, you ran through some numbers earlier in your presentation that – but they were a little fast for me. Can you give us a little bit more color on where you see the financial expense and depreciation ending up for 2015? And then, the second question was after a few months now of having your feet under the table, are there any bits of the organization as you look at it now that you can see opportunities to sharpen things up further? Or alternatively, bits of the organization where with your experience you think you need to add more people or systems? Michael Sen Yes, look, on the depreciation side of things, I mean, you’re obviously referring to what comes below the line. I said that I expect larger alleviation or buffering from depreciation. That means in Q4 we will see materially lower depreciation compared to last fiscal – to last calendar Q4, because of the E&P effect of the accounting effect. So you cannot take the run rate which you see on depreciation. You have to significantly hike up the improvement on the depreciation side. And, on the financial expense side, I’d say this is roughly in line. Yet, there could be, there could be some – we always have to watch the interest rate development, if interest rates – because in the interest expense line you have all long-term liabilities. Now, if interest rates – and there is pressure to go more to the lower end – then you will see some uptick on that one, i.e., the improvement will be a little buffered away, but the main item will be the depreciation. Anke Groth Bobby, your second question was around the organization, if we need to add more people or systems, or if we are in a stable and steady state? Bobby Chada Yes. Michael Sen Yes, look, at first I think, Bobby, we currently have to get the spin done. The organization is pretty much busy getting the split done and getting from one end to the other, and creating Uniper and then creating new E.ON. Now, in terms of how is this going to pan out going forward, I mean, I don’t want to go too far, because Uniper management at some point in time has to present their equity story to you guys. But I think it goes without saying that you have – that they will have to have a high cash flow focus and, concurrently, a high cost focus. They will have to tell you guys, how they see their cost structure vis-à-vis their new setup, which is a different setup than being part of a larger conglomerate. And that’s why I say, I don’t want to go too far, it’s their story, but us also being a shareholder going forward, not only 100% in the near term, but in the midterm an essential shareholder, I would expect that we talk about very sort of appropriate cost structures, given that you have a new set-up for that entity. For E.ON, by the way, this whole rigor I talked about, when I talked to you the first time, getting more market into the company and getting into a continuous improvement, also on the cost side will be key. We all know that a split like that, at first, creates some dis-synergies, obviously on the cost side, because suddenly you need two accounting departments, you need two IT departments, you need two HR departments, and the like. So going forward, in our industry I think it is clear that we also need to focus next to capital allocation on cost efficiency. The only thing I would say is that you do this in a more continuous improvement manner and not go with the hammer through with specific programs, and taking management consultants and so forth. This was probably necessary in the past, other than that the sector would not have survived. But going forward, it has to go more into a continuous improvement mode, and I think we all have the levers in place to do that. Bobby Chada Great. Thank you. Operator The next question comes from the line of Nathalie Casali of J.P. Morgan. Please go ahead. Nathalie Casali Hi, good morning. A question from me on the impact of the impairment from D&A. And is it fair to assume that roughly €3 billion of PT [ph] impairments will lead to about €150 million reduction in D&A from 2016 onwards? And the second question is a very small question on the provision reversal in the German supply business. Can you just give some details on that? Thank you. Michael Sen Okay. Let me first of all take your first question. Rightfully, you said the asset impairment as such is roughly €3 billion out of the €8.3 billion but the assumption –would not concur to the assumption that it is, what did you say, €120 million or something like that? It is more in the neighborhood of – north of €50 million. The E&P business had major impairments – major, major impairments. Actually, the E&P business had, I said that in the press call, an impairment of roughly €1 billion and that asset will leave our company, all fingers crossed, if we get the closing done in Q4, which by the way, will have a positive impact if and when we get it done on the economic net debt. Anke Groth Could you repeat your second question, Nathalie, please, and welcome back, by the way. Nathalie Casali Thank you, thank you. Yes, it was just about the reversal of this provision in the German non-regulated business in Q3. I expect it’s small, but I just wanted an indication. Michael Sen The indication was – I’d say if you take roughly €30 million-ish. Nathalie Casali Okay. Thank you. Michael Sen And this was – I guess you are referring to the German heat. It’s a biomass topic and it’s roughly €30 million and this had the increase on EBITDA. Nathalie Casali Okay. Thanks very much. Operator The next question comes from the line of Andreas Thielen of MainFirst. Please go ahead. Andreas Thielen Yes, good morning. Firstly, with your guidance on the economic net debt for the full year, could you help us a little bit understanding the dimension of the reversal in working capital? And as a second element, you mentioned that there might be some consideration on the discount rate for nuclear provisions for the full year. Is there anything you can give us in terms of sensitivity or direction there? That would be helpful. And secondly, on the operational business, I noted that – although that might sound small as well, I noted that there has been some considerable improvement in Q3 in the spread business in generation. Is that an ongoing trend where you benefit, basically, from markets getting more short term there, or what has been the driver? Thank you. Michael Sen Okay. Let me start with your first question on economic net debt. Look, I think you see on the chart what’s driving the economic net debt today. It’s the high operating cash flow, and then against that goes the investment of €2.7 billion. Now, for the full year how would I guide you through that? If you take our EBITDA guidance, which is €7.6 billion, and you would take something like a midpoint €7.3 billion, €7.4 billion. And you would apply the cash conversion rate I have been guiding to earlier, and I said at the upper end, like [Technical Difficulty] and so you would see that out of operating cash flow, I do not expect any big movement for year-end. So the operating cash flow would on the contrary, probably not be €5.7 billion, but rather a little lower. Then again – but only a little lower. Then again the investments to date, €2.7 billion, we guided the market for €4.4 billion, I told in my speech another €1.5 billion going against the economic net debt. And against that €1.5 billion, so if you say the operating cash flow is almost awash and against the €1.5 billion negative on investments we get from divestments [Technical Difficulty] and then we also expect the hydro and this is almost awash. And then, everything staying equal, I would be – if there’s no big movement on interest rates, we should be in the neighborhood where we are today. In Q4, what we do expect on the operating cash flow is the working capital is going to reverse tremendously. That’s why I mentioned I expect cash out – major cash out for CO2 certificates. I expect receivable buildup; this is calendar yearend for every customer facing regional entity. So what you usually do, you post revenues and then your receivables go up and this goes against your working capital. These are the items driving the whole thing. Now, your second question was? Andreas Thielen The second question was just – firstly, if I could, on the first question, just shortly, the – anything in terms of sensitivity or indication on the nuclear provision side? Michael Sen Yes, that’s what I wanted to say. This is – you’re right, it’s part of the first question, because the arrows are also there. For Q4, I do not expect major movements. Now, that this thing is highly sensitive to interest rates, I think this you could see in the stress test, which you could download from the Minister of Economics, that if you play around with the interest rate by 100 basis points, this just moves a lot on the tail end. But now, near term, for the Q4, I do not expect major movements. So, your third question was? Andreas Thielen Just on if there has anything changed in the underlying business in spread generation, i.e., coal and gas, if you have more benefits from short term prices there or balancing power? Michael Sen No. Andreas Thielen Okay. Thank you. Operator The next question comes from Peter Bisztyga of Bank of America Merrill Lynch. Please go ahead. Peter Bisztyga Yes, good morning. Just one question from me about the impact of the recent decline in wholesale gas prices. Can you sort of elaborate how quickly you expect that feed through into your remaining E&P asset, which I guess is Yuzhno-Russkoye, and also through your midstream and downstream gas activities, please? Michael Sen Yes, hi, Peter. First of all, you always have some sort of, how could I say, a two months delay. But what we have seen in E&P, obviously, was already pressure year-over-year by – also on Yuzhno-Russkoye by the negative buffer price of roughly €50 million, in that neighborhood. And obviously, with a specific time-lag you would see the pressure of the gas prices in there. So in E&P you have the pressure from the gas price, you have the much bigger pressure from the oil price, which is in the neighborhood north of €200 million. Against that, we have positive FX impact. And as I told you for year – for the full year we expect volumes to be holding up, but the gas price, clearly, and the oil price is much bigger, and having an impact going forward, so that also in Q4 you will see some impact. Peter Bisztyga I’m sorry, on your midstream activities, please? Michael Sen No. There I would not see any impact right now. I mean, there we would have come back to you. Peter Bisztyga Okay. Thank you. Operator The next question comes from the line of Alberto Ponti of Société Générale. Please go ahead. Alberto Ponti Yes, good morning. Just a quick update, one on – is on the state of the play with the nuclear fuel tax, your sort of latest thoughts as to when this may happen? And also, your thoughts on the rest of the E&P business, UK and Russia, is it going to stay with the group, or you’re thinking otherwise? Thank you. Michael Sen Rest of the which business? Anke Groth Turkey [ph] and Russia stay with the group or getting out of it… Michael Sen Turkey goes to new E.ON, and Russia goes to Uniper. That’s the split logic. And on nuclear fuel tax, we can basically keep it short. The court decided to come up with their decision later. We were expecting it to happen this calendar year. Now they pushed it into next year, and there’s nothing much we can say about that one. Alberto Ponti Yes – sorry, my question was more about, are you going to keep or sell E&P assets, the remainder? Michael Sen So E&P assets, keep or sell, look these, no, the Russian asset, the gas field, the Yuzhno-Russkoye gas field goes to Uniper, there is no intention to sell that. It’s actually a very attractive asset, by the way, and paying very attractive dividends, where E.ON is also today benefiting, and will hopefully benefit going forward. On the E&P North Sea, we said it’s under strategic review. One asset has been reviewed, and it’s already transacted upon. The other one, the UK one, we’ll update you as we go along. Alberto Ponti Thank you. Anke Groth So I think we are running out of time. Maybe we could add a couple of minutes, but no longer. Otherwise, we will get problem with the minute of silence. But Deepa, please go ahead and maybe you could limit yourself to the most important question? Deepa Venkateswaran Thank you. This is Deepa from Bernstein. I have one follow-up question from earlier on, and one new one. So in terms of net debt you basically said that you expect to stay where you are on net debt, barring any big movements in the discount rate. Could you clarify whether that was including the disposal proceeds from Italian Hydro and Norway? A second question is really on the Nuclear Commission. What are your expectations, process-wise and outcome-wise? Michael Sen Yes, Deepa. The first one is short, yes, it includes it. That one buffers the investment which will go out in Q4, which is – has the lion’s share in Q4, €1.5 billion of CapEx still to be spent in Q4. And against that go the proceeds of hydro and E&P, so yes. Nuclear Commission, well I wouldn’t – I said it all along during the road shows in the last couple of weeks. We have passed the stress test, this was an important milestone, also in the way it was positioned. It was an important milestone, yet it goes into the next process where the Nuclear Commission is working. And by the way, the stress is confirmed. It is important to again stress that it confirmed everything which we had accounted for. Everyone else also, but for us, obviously, it’s important what happens to us. Now the commission takes this as an input, I said one data point. It’s not the data point, it’s one data point. The commission will come up with a proposal, already said they’re going to come out in February, initially they said in January, but I guess they need some time to work. And then it is in the decision making of the minister, and probably Office of the Chancellor, to come up with the solution. They will also make a proposal. A minister positioned it in a way that the commission will come up with a proposal, and he is going to look at it. Now, the way we’re going to deal with it is, we’re going to work intensely and constructively, like, by the way, we did with the stress test, and make our point clear. But it’s too premature, and I think it would not be prudent to come up with any speculation right now as to what the outcome would be. That would be rather detrimental. In the press call, I also heard a lot of buzz words from funds and trusts and what have you. At the end of the day, it all depends, right? It’s what you read in all the terms and conditions attached to a solution, what it really means. But I think it’s too premature to spill out something from our side. We will be happy to chip in to contribute, which will happen, they already invited us. And then, we will talk with them behind closed doors, or maybe even open doors if it’s a public hearing. Deepa Venkateswaran Thank you. Anke Groth Deborah [ph], last and final question. Unidentified Analyst Yes, thanks. I was hoping you could help us with the generation division in terms of the nuclear tax paid so far. Expectations for the fourth quarter, this year versus last year, just to get a sense of the underlying? Michael Sen €2.7 billion. Unidentified Analyst No, sorry. In terms of the 2015 earnings run rate? The expectation for payment in the fourth quarter this year, and whether or not there as a payment last year? Michael Sen €400 million. Okay. That was it, I guess. Anke Groth Yes, I think unfortunately we have to terminate the call, to not run into a problem. Thank you for participating and asking your questions. Ingo Becker, unfortunately, you’re the last person on our list. Please give us a call, and… Michael Sen Yes, we’ll take care of it. Anke Groth We’ll work through your questions. Thanks a lot. Yes, talking to you soon. Bye-bye. Operator Ladies and gentlemen, thank you for your attendance. This call has been concluded. You may now disconnect.

American States Water Company: A Helping Hand Boosting Growth

American States Water Company’s shares have become undervalued as a result of negative earnings results in the past. This undervaluation does not take into account the favorable Californian regulatory environment that could help move the company along. Investors looking for a stable, long-term investment opportunity with the potential for capital appreciation should consider picking up the company’s shares. As investors know, utilities companies are some of the most stable companies that investors can invest in. These companies are known for their strong, stable balance sheets that regularly doll out steady income in the form of dividends. Not many investors would consider utilities companies as investments for risk-loving investors, given the fact that demand in the utilities industry is so inelastic. This inelasticity stems from the fact that consumers will purchase utilities services no matter what happens to the general economy; after all, no one in their right mind would save money by cutting off their water or heat. But small cap utilities companies can offer investors looking for something else a chance at both capital appreciation and steady income. Given the nature of small cap companies, small cap utilities companies give investors the chance to outperform the general market without too much risk involved. This is not to say that company-specific risk can still play a role in increasing the overall risk in a portfolio, but industry-wise, the risk in that aspect is rather low. One small cap utilities company that investors should consider taking a look into is American States Water Company, Inc. (NYSE: AWR ), a pure play water company that mainly serves customers in California by providing water and electric utilities services. The company operates through two main businesses: Golden State Water company and American States Utility Services, and each of these business segments has their own individual subsidiaries. Golden State Water company contains Golden State Water, a regulated water utility company, and Bear Valley Electric, a regulated electric utility company. Furthermore, American States Utility Services contains a number of subsidiaries, including: Fort Bliss Water Services company, Old Dominion Utility Services, Old North Utility Services, Palmetto State Utility Services, and Terrapin Utility Services. All of these subsidiaries enable a strong amount of diversification within the company’s sales mix, which enable investors to share in that diversification indirectly through an investment in the company’s shares. Moving on to the company’s stock chart, investors can see the outstanding returns that the company has generated for investors. Funds invested in the company on the onset of calendar year 2011 would have generated a return on investment of more than 150%, not bad for a utilities company. While the company has had a great turn in the years 2011 throughout 2014, the company’s shares recently began slowing down in value growth. That, in part, is due to macroeconomic events out of the company’s control, and thus, investors should not discount the stock due to a slowdown in value growth throughout 2015. In regards to a technical perspective, the 50-day moving average has been basically above the 200-day moving average for the most part, with the 50-day moving average occasionally touching the 200-day moving average. The two technical indicators’ spread have been widening recently, which could signal near-term upside. (click to enlarge) Source: Stockcharts.com From a fundamental standpoint, long-term investors have much to feast upon. The California water utilities regulation has been particularly favorable in the sense that regulators are taking action to make processes more streamlined and adjust the way that water usage is measured. Through this favorable regulatory environment, the company can once again augment its customer expansion and increase top-line growth. As a result of numerous earnings calls in the past that yielded negative earnings growth, investors have discounted the stocks’ investment potential, but these investors fail to see the long-term picture. As such, shares of the company have become undervalued and are ripe for pick up by value investors with that long-term perspective in mind. Growth in EPS has been unsteady, but that could change with this favorable regulatory environment as the company streamlines its operations and widens its margins, boosting EPS. While the utilities industry is indeed a heavily regulated industry, and while industries that are heavily regulated are subject to the whims of the government, in this case, that’s a good thing. The company will have a helping hand prop up and reignite its growth engines. Investors looking for a stable, long-term investment that has the potential for capital appreciation should consider investing in American States Water Company.