Remaining strong
We initiate coverage on E.ON and RWE with Buy ratings and target prices of
€37.1 and €88.7, respectively. We like E.ON for its strong long-term fundamentals
despite some overpayment in recent acquisitions. RWE is more leveraged to oil
prices but, on our estimates, it is a cheaper stock that is being transformed.
Table 1 : Key metrics
Company Share price
(€)
12-mth
target price
(€)
Upside
potential
(%) PE (x) 2009F
EV/EBITDA
(x) 2009F
Div yield
2009F (%)
E.ON 25.87 37.1 43.4% 8.22 5.40 6.5%
RWE 60.11 88.7 47.6% 8.61 3.97 5.8%
Prices as of 14th January 2009
Source: ABN AMRO forecasts
Operational performance should remain healthy even after oil price decline
We expect high earnings growth for E.ON and RWE until 2010, as a large part of baseload
output has been sold forward, while the contribution from unhedged fossil-fuel plants should
improve in line with a recovery in electricity spreads. Our average annual EPS growth
forecasts exceed 10% for both stocks in 2008-10. We also think the trend of realised
electricity prices should flatten after 2010 as the steep futures curve suggests a commodity
price recovery. With the regulatory risk in Germany behind us, the main earnings driver from
2010 onwards should be contributions from new organic investments, which we expect to
generate attractive returns (7.9% and 10% ROIC on incremental capital employed for E.ON
and RWE in 2007-12F).
Higher CO2 price can be positive for both companies
Phase II of the EU’s Emission Trading Scheme showed that electricity producers are able to
pass through higher carbon costs to end consumers, which makes us believe that a higher
CO2 price will be, in absolute terms, positive for E.ON and neutral for RWE. We think full fuel
switching is currently not possible in Germany due to a lack of available gas capacity.
Improving business models despite more cyclical nature
E.ON has improved its business model through recent acquisitions at the cost of
overpayment, in our view. We estimate the economic loss at €3.4bn, and we believe it has
been priced in after the stock’s underperformance in 2008. In the case of RWE, we expect a
big transformation in the coming years due to a large capex programme and the announced
acquisition of Essent. We like E.ON’s long-term fundamentals more due to a lower leverage
to oil prices, lower business risk and a much better position in the tightening CO2 regime.
Significant upside even without nuclear extensions
We initiate coverage on E.ON and RWE with Buy recommendations and 12-month target
prices of €37.1 and €88.7, respectively, corresponding to 43% and 48% upside potential. Our
assumptions do not include nuclear lifetime extensions even though these could result in
significant additional upside. We forecast secure dividend yields in 2009 of 6.5% for E.ON
and 5.8% for RWE (using the bottom end of the companies’ dividend/growth payout
guidance).

Contents
Strong reasons to buy 5
We believe E.ON and RWE are attractive with upside potential of 43% and 48% to
our target prices, respectively. We like E.ON’s long-term fundamental prospects
better despite the lower relative value that we see in the stock.
5
Arguments to buy both stocks 6
Time for more differentiation 10
The change of rules 13
Decline in the oil price removes a major earnings driver for German utilities while
the main trigger for future performance is the sector’s investment cycle. We think
E.ON is better positioned for both developments despite RWE’s recently announced
acquisition.
13
The end of commodity run – how great is the leverage? 13
How much have the companies changed in the past three years? 19
Capex programmes – so different 21
Nuclear lifetime extensions – great uncertainty 25
Regulatory regime – the worst is behind us 26
Financing needs – debt markets remain open 27
Unknown equilibrium 28
The next major event for the German electricity system and the shape of the merit
order will be the introduction of Phase III of the ETS. We believe higher CO2 prices
are positive for E.ON and neutral for RWE. Full fuel switching in Germany is not
possible.
28
Is the German electricity system really tightening? 28
Rising carbon price can be positive 30
Major assumptions 38
These are our detailed assumptions on commodities, the macro environment and
the electricity sector.
38
Company profiles
E.ON 39
E.ON’s shares offer an attractive investment opportunity, in our view, as most of the
negative news flow seems priced in after the stock’s underperformance vs the
sector in 2008. We initiate coverage with a Buy rating and 12-month target price of
€37.10 implying 43% upside potential.
RWE 63
RWE is investing heavily to address the strategic problem of an old and polluting
generation portfolio. The stock looks undervalued, in our view. Based on our target
price of €88.70, we see 48% fundamental upside from the current level