* Iberdrola gets 76 pct of core earnings from grids, wind
* Focus on regulated assets a plus in weak energy markets
* 80-85 pct of investment to go to UK, U.S., Brazil, Mexico
* Shares outperform peers, but Spanish reforms are a threat
By Geert De Clercq
PARIS, Oct 22 Spanish utility Iberdrola is sharpening its focus on power grids and wind energy abroad to compensate for local regulatory headwinds that threaten profit growth next year.
Iberdrola, a world leader in wind turbines, gets three quarters of its earnings from low-yielding government-regulated assets since buying Scottish Power and U.S. Energy East in 2007-2008 before the euro zone crisis began.
Those two purchases made Iberdrola, Europe's fifth-biggest utility by market value, look like the tortoise of the sector at a time when European peers were selling off their grids, seen as low-return assets, to focus on power generation and retail.
But a prolonged recession and a renewable energy boom have pushed wholesale power prices down to about half the level of 2008, hammering the profits of utilities like Germany's E.ON and France's GDF Suez.
With the industry also up in arms over unexpected policy shifts in Europe, such as Germany's decision to phase out nuclear power, Iberdrola's bet on power grids in Britain, the United States, Brazil and Mexico is starting to look clever.
Rebasing Iberdrola's share price to 100 in mid-2008, when electricity prices set record highs, it now trades around 65. Not great, until you compare it with the broader European utilities index at 48 and E.ON at just 33.
"The paradox is that utilities in peripheral southern Europe, because of their focus on regulated grid assets, have a lower business risk than utilities in core Europe," said Madrid-based Kepler Cheuvreux utilities analyst Jose Porta.
With little prospect of a rapid economic recovery in Europe, Iberdrola is sticking with the focus on power grids overseas.
"This is our core business now. We have much more transmission and distribution than power generation. We are more like National Grid than like E.ON," Chairman and CEO Ignacio Galan told Reuters in an interview, referring to Britain's electricity network operator.
"Eighty to 85 percent of our investment is going to the United States, Britain, Brazil and Mexico. That is where we get the most growth, most predictability and stable regulation."
FOCUS ON GRIDS
Power networks are projected to take up the bulk of Iberdrola's planned 10.5 billion euros of investments in 2012-2014, with 3.6 billion in distribution and 1.84 billion in high-voltage transmission. Forty percent of the network investments will go to Britain and 25 percent to the United States, where analysts say cash flows are relatively safe.
"Investing in grids with a stable regulation gives visibility on the utility's cash flows, making the company more attractive for investors," said Jose Martin-Vivas, an analyst at Mirabaud Securities in Madrid.
Iberdrola, which publishes nine-month results on Wednesday, plans to invest up to 10 billion euros in UK networks over the next decade. Its flagship project - together with National Grid - is a 1 billion pound subsea cable between Scotland and North Wales, the largest of its kind in the UK.
In the United States, where it owns 25,000 miles of distribution lines and 2,700 miles of high-voltage transmission lines in Maine and New York state, Iberdrola is halfway through a $1.4 billion grid upgrade.
"We have more than doubled our investment there, and this will increase because of the need for more electrification in those states," said Galan, a former telecoms CEO who joined Iberdrola as CEO in 2001.
At the end of June, 76 percent of Iberdrola's core earnings came from its regulated energy business, with 48 percent from networks, 23 percent from renewables and 5 percent from its regulated generation business in Mexico.
RISKS IN SPAIN
But if a focus on regulated assets shields a utility from the economic cycle, one major risk remains: the regulator.
In Spain and Brazil, two core markets for Iberdrola, regulatory changes are set to be the main challenge for 2014.
In Brazil - where Iberdrola owns power distributor Elektro and has a stake in Neoenergia - President Dilma Rousseff is looking to cut power rates again, a year after a forced tariff reduction.
The biggest regulatory threat comes from Iberdrola's home market. In July, Spain announced an energy reform aimed at eliminating a power tariff deficit built up over years of setting regulated prices below the cost of production. The reform includes cuts to both subsidies and payments on renewable energy and distribution assets - Iberdrola's key businesses.
Iberdrola has indicated a 170 million euro pretax impact in 2013 and 260 million in 2014 from the measures, and Credit Suisse sees a further 100 million hit from a cut in remuneration for wind power, putting at risk the firm's 2014 targets.
Analysts say deep cuts to payments for wind power could also push the company to reduce its dividend policy.
Iberdrola, which has around 29 billion euros of debt after its expansion, is delaying a 2014 strategic review until early year, once the government gives details of the new energy law.
Credit rating agencies too are watching the reform closely.
Fitch - which rates Iberdrola BBB+ - put several Spanish utilities sector on rating watch negative in July, which means there is a high likelihood ratings will be downgraded in the coming six months should new regulations impact credit metrics.
"New Spanish legislation on renewables is a major regulatory risk for Iberdrola, and its rating will depend on how that legislation is implemented," said Francesca Fraulo, southern European utilities specialist at Fitch Ratings in Milan.