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Edited Transcript of ELE.MC earnings conference call or presentation 23-Jul-19 8:00am GMT

Half Year 2019 Endesa SA Earnings Presentation

Madrid Jul 26, 2019 (Thomson StreetEvents) -- Edited Transcript of Endesa SA earnings conference call or presentation Tuesday, July 23, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* José Damián Bogas Gálvez

Endesa, S.A. - CEO & Executive Director

* Luca Passa

Endesa, S.A. - CFO and GM of Administration, Finance & Control

* Mar Martinez

Endesa, S.A. - Head of IR

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Conference Call Participants

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* Alberto Gandolfi

Goldman Sachs Group Inc., Research Division - Head of European Utilities Research

* Anna Maria Scaglia

Morgan Stanley, Research Division - Research Analyst

* Enrico Bartoli

MainFirst Bank AG, Research Division - MD

* Harry Peter Wyburd

BofA Merrill Lynch, Research Division - VP and Junior Analyst

* Javier Fernandez Garrido

JP Morgan Chase & Co, Research Division - Head of Utilities and Senior Analyst

* Javier Suarez Hernandez

Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst

* Jorge Guimarães

JB Capital Markets, Sociedad de Valores, S.A., Research Division - Analyst

* Jorge Alonso

Societe Generale Cross Asset Research - Research Analyst

* Manuel Palomo

Exane BNP Paribas, Research Division - Analyst of Utilities

* Meike Alina Becker

Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst

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Presentation

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Mar Martinez, Endesa, S.A. - Head of IR [1]

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Good morning, and welcome to our First Half 2019 Results Presentation which will be presented by our CEO, José Gálvez; and by our CFO, Luca Passa. Following the presentation we will have the usual Q&A session open to those connected both on the call and on the web.

Thank you very much for your attention, and now let me hand over to José Gálvez.

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [2]

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Thank you, Mar, and good morning, ladies and gentlemen, and thank you for joining us today. As usual let me start this presentation with the main highlight of the period. EBITDA increased by 5% compared to last year, mainly due to the positive performance of the liberalized business, flat EBITDA evolution in the distribution business. Fixed cost has remain almost flat as our continued focus in efficiency has assured the increased investment effort. At the bottom line, net ordinary income increased by 3% compared to the first half 2018.

Finally it is worth taking into account the progress made so far on developing our strategic pillars and at leading the energy transition. In that sense, moving onto Slide #3. Let me now comment on the achievement recorded so far on the main operating target of our business plan.

Our focus on renewable have resulted in an acceleration of the development of the 879 megawatt obtained in the 2 auctions held in 2017, with that which are expected to be onstream before end 2019. Apart from the renewable project on the mainland, Endesa participated in auctions held in the Canary and Balearic Islands where we intend to invest also outside the auction scheme. A sound pipeline of 9 gigawatt in renewables is being developed, reinforcing our leadership in the energy transition.

When it comes to grids, we continue digitalizing our networks. During the last 18 month, we have devoted a CapEx of EUR 370 million, around 37% of the committed amount for 2019 to 2021. The effect of this investment has a direct positive consequence in efficiency indicators such as OpEx per customer. Our customers' strategy oriented to value creation remains successful with first half 2019 integrated margin reaching EUR 27.5 per megawatt hour, an 8% increase versus last year. And we keep on progressing on our digitalization effort to manage our customer base while improving the cost to serve.

And finally, we are meeting our efficiency target while containing our fixed cost within the new investment cycle in which digitalization is playing a key role, leading progress evolution throughout the company.

Focusing on the first pillar of our strategy on Page #4. As you may know, the Spanish National Energy plan was submitted to the European authorities last February with an 2030 emission reduction target and the energy sector objective to reach the European Union environmental target. These are one of the most ambitious in the European Union, reflecting the willingness of the government to lead the energy transition in Europe. We are strongly supportive of the energy transition and the ambitious Spanish target and aim at being the leading player throughout this evolution.

In the short term, and as I commented on before, Endesa is developing 879 megawatt of renewable project awarded in the 2017 auctions, devoting more than EUR 800 million of CapEx, which are expected to be onstream before end 2019. Being fully committed with sustainable financing policies, 80% of this CapEx has been secured through 2 [green] loans with the Instituto de Credito Oficial and the European Investment Bank in very competitive terms and condition. Endesa is a pioneer in this kind of financing in Spain. We are also working on developing a sound pipeline of around 9 gigawatts, out of which 1.8 gigawatts with commercial date until 2021. Most of the capacity in the advanced phase development will be solar, around 85%, with an evident switch from the wind technology.

Moving now to Slide 5. Let me now explain our smart networks being our second strategic pillar. Last 5th of July, the CNMC published 7 circulars with its proposal for the second regulatory period of electricity distribution and transmission for the period 2020 to 2025 and that's distribution, transportation and regasification businesses.

The main effect in power distribution are the proposal of a reduction from 6.5% to 5.58% in the remuneration rate now based on a WACC formula in line with its November 2018 proposal and gradual cut in OpEx efficiencies and a new incentive scheme. The 50 basis points cap [and flow] in the regulated return changes over 2 consecutive year remain the same.

These drafts are open for confrontation until August the 9th and the CNMC expects to have the final document by the last quarter of this year 2019. New regulation will be in force by 1st January, 2020. We are currently working on the allegation report to make improvements on the proposals.

From our point of view, another grid regulation should encourage companies to prepare their investment and operation plans in accordance with national energy policy objective. We should all focus on achievement the objectives of the integrated National Energy and Climate Plan to advance the decarbonization. For this target to achieve, a proper remuneration for the electricity network is crucial, specifically on serving investment in digitalization where an adequate (inaudible) framework should be established.

The third pillar of our strategic plan is concerned now on Slide #6. The strategy implemented in the retail business has so far have very positive effects of all the business indicators which are flat churn rate in electricity despite growing competitive pressure. To the contrary and most notably, the gas churn rate improved versus full year 2018, exceeding our expectations. The number of contract with e-billing rose by 67% versus full year 2017 up to 3.5 million contracts. The proportion of digital interaction rose from 68% in 2017 to 86% in the first half 2019, while the number of digital contracts has grown to 4.5 million. Both metrics are already exceeding the 2021 target.

All of the above has allowed a relevant reduction of the cost to serve, paving the way for additional savings in the upcoming years.

Moving now to Slide #7. To make a quick follow-up of our efficiency program, which is consistently proving to be an effective tool to achieve efficiencies across all our business lines. Our OpEx evolutions remained stable versus previous year with efficiencies including IFRS 16 effect more than offsetting inflation, perimeter and growth with higher CapEx in the new investment cycle.

In relation, the optimization measures put in place allowed us to keep on containing our generation unitary cost. In the same way regarding energy and power Spain, cost synergies incentive allowed us to deepen the fixed cost control reaching EUR 42,000 per megawatt in the first half 2019 with an improvement of 2% versus full year 2018.

In distribution, the digitalization initiative of our processes and asset brought additional reduction in our operational cost with unitary cost per client at EUR 42 per customer. That is minus 2% versus full year 2018, close to 2021 target.

Lastly, regarding supply, [lingering] on the digitalization initiative, we have trimmed the cost to serve to EUR 10.6 per customer towards our EUR 8.3 per customer target to fall 2021 which has been adjusted for the social bonus cost.

Moving to Slide #8. You can see how the execution of our strategy affects our sustainable KPIs. And thus as a strategy deepens our commitment to the sustainable development goals set by the United Nations.

In relation to SDGs, we have achieved around 60% of CO2 free energy production against a target of 52%. Also, in digitalization we have forecasted a total investment of EUR 1.3 billion during the period 2018 to 2021, of which EUR 102 million was invested in the first half of 2019, being 30% of the annual target.

Regarding our commitment to ensure electricity supply to all vulnerable customer, we are implementing 38 initiative that has so far helped 330,000 people to gain access to energy.

In relation to our engagements with local communities, Endesa has implemented a Fair Transition on the Compostilla and Teruel coal plans phase out consisting of project to give a Second Life to the Compostilla site and to build a 1,000 megawatts of photovoltaic capacity in Teruel, the biggest solar plant in Europe. Besides this project, we are promoting local employment jointly with other social, environmental and energy efficiency initiative in the renewable project we are setting up. And finally, our involvement with our employees where we are almost reaching 2019 target for a diversity price outperformance sustainable mobility and health and safety.

Let's take a look at Slide #9. Our commitment to sustainable development goals, I would like to underline some achievements in the environmental, social, governance dimension. Regarding the environment, the Spanish Climate Change Office has selected Endesa to develop new climate projects to reduce emissions. Also, it has [35] as at the first Spanish energy company to offset its carbon footprint. We launched a zero plastic campaign to reduce single-use plastic by 75% over 5 years. Endesa has been the first Spanish utility to obtain green loans from Instituto de Credito Oficial and the European Investment Bank.

In relation to the social dimension, the creating (inaudible) value approach in our deployment of the photovoltaic plant has succeeded in creating 660 jobs in Extremadura. Our successful Retotech projects to foster education and innovation through technological enterprise in schools has been selected for the European Initiative Enterprise 2020.

Finally, when it comes to governance, Endesa has improved its governance model with the election of a nonexecutive independent chairman as well as increasing up to 55% the independent board members. Management remuneration includes CO2 emissions reduction and safety target. The independent organization Fundación Compromiso y Transparencia awarded Endesa as the Best Company on Tax Transparency in Spain and confirm our foundation as a leader of the transparency and good governance index. Our sustainability plan embedded in our strategy allowed us to renew our presence in FTSE4Good and Euronext Vigeo indexes.

Now on Slide #10, I would like to comment on the market context in Iberia for the period of the financial release. Spanish electricity demand showed a decline both in growth at minus 2.2% and adjusted tariffs, minus 2.3% affected negatively by milder temperatures during the period as well as by a closure of aluminum factories in northern Spain.

In Endesa's concession area, gross demand decreased by 1%, slightly better than mainland figures and remain almost flat in [adjustment at the asset terms]. This development is mainly driven by the service activity which could not offset in non-adjusted terms the growth in (inaudible) temperature reasons. Electricity pool prices rose slightly to EUR 51.8 per megawatt hour on average during the period, below 2018 full year price references and 3% higher than first half 2018. Behind this price scenario lies the combined effect of hydro scarcity, lower wind load factor and the material increase of CO2 prices seen during this period.

In this context, Endesa's total output dropped by 13% largely due to the reduction in hydro and thermal generation minus 47% and minus 32%, respectively, while nuclear output which was fully normalized after last year stoppages partially offset this reduction. As a consequence of all these effects, CO2 free technologies increased (inaudible) up to about 60% of our generation mix, (inaudible) 33% in the first half 2018.

Moving to power operational highlight on Slide #11. Total gross sales decrease 1.5 terawatt an hour, that is minus 3% mainly due to the growth in Spanish demand as a consequence of mild temperatures, as I mentioned before. (inaudible) by segment shows a drop in residential volumes, while industrial sales maintain a more moderate decline. Note that our commercial strategies targeting the retention of higher-value customer that trigger the exit of some industrial customer which has narrow margins over the course of 2018.

To the contrarily, electricity customer remain almost in line with last year's figures, although improving the mix following the switch from regulated to the liberalized segment, whose customer base increased by 2%. Our objective is keeping our overall market service stable.

Moving to Slide #12. Electricity sales in the liberalized business decreased in Spain and Portugal by 2% in terms of volume. That is minus 0.9 terawatt hour. The unitary integrated margin in the electricity business increased by 8% to EUR 27.5 per megawatt hour. The result of this remarkable evolution are mainly due to the higher OTC reference prices, the positive impact of the temporary suspension of the [introduction] tax in the first quarter and higher nuclear production. These factor partially offset lower hydro availability and lower thermal spread as a consequence of the significant increase in CO2 prices. It is also worth underlining the soundness of our liberalized supply margin which stays at around EUR 9 per megawatt hour from close to EUR 8 per megawatt hour in first half 2018. We have already hit 100% of our 2019 estimated output at an average all-in price of EUR 72 per megawatt hour.

For 2020 we have hit around 70% of our estimated output at an average all-in price of around EUR 76, corresponding mainly to hydro, nuclear and renewable production. This price reference corresponds to low voltage customer. Therefore, prices will gradually normalize around the year at around EUR 72, similar to 2019.

Regarding Slide #13, the backdrop for global gas is still affecting the performance of our gas business. Milder temperatures during the period impacted total sales with a 6% drop mainly in the retail activity and in particular in the international market. On the other hand, sales of CCGTs sharply improved by 20%.

At the bottom of the slide, however, you can see that the number of customer increased by 2%, consolidating levels of EUR 1.6 million. The increase in the hedge selling prices carry out last year outstood the higher procurement costs, allowing the unitary margin to increase to EUR 2.3 per megawatt hour.

Let me mention that we hedge 100% of our 2019 estimated sales among retail CCGTs and diversions. Considering 2020, this figure amounts to around 53%.

And now Luca will continue with the financial results.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [3]

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Thank you, Pepe, and good morning, ladies and gentlemen. I am now on Slide 15, [regarding] the main financial results for the period.

EBITDA and net ordinary increased by 5% and 3% respectively compared to first half 2018. The main drivers behind this performance are remarkable evolution of the liberalized business in a challenging market context for both electricity and gas businesses while at the same time, regulated businesses remained stable. The continuous efforts in efficiency led to a 2% decrease in the fixed cost.

Net ordinary income increased 3% affected by higher financial cost, MD&A in the period, as I will detail later on. Finally, net debt increased by 18% over full year 2018 to EUR 6.8 billion mainly driven by higher CapEx, the first adoption accounting entry of IFRS 16 for 186 million and the interim dividend of 2018 results paid in generally this year amounted to EUR 741 million.

Moving to the retail analysis and the EBITDA, I'm now on Slide 16. Let me summarize the main drivers. Endesa report an EBITDA of EUR 1,894 million plus 5% versus first half 2018, an increase which has been driven by the good performance of the liberalized business and stability of the distribution business, as well as by the ongoing efficiency driving a 2% reduction in OpEx, 1% in adjusted terms.

Generation and supply EBITDA rose by 21% to EUR 745 million, supported by the sound increase in integrated electricity and gas margin jointly with a fixed cost reduction. Distribution EBITDA came in at EUR 1,025,000,000, increasing 1% thanks to an improvement in gross margin mainly from the consolidation of (inaudible) and lower OpEx.

Finally, non-mainland generation EBITDA reached EUR 124 million, as I will comment in the following slide.

Regulated business contributed to total EBITDA with 61%, and I'm now on Slide 17. EBITDA decreased by 3% to EUR 1,149 million affected by a lower regulatory margin of EUR 37 million while fixed costs remain flat. Distribution slightly increased by 1%.

The non-mainland generation gross margin was EUR 45 million lower due to the reduction of the revenues related to fuel and CO2 compensation as a result of the settlement mechanism in non-mainland which uses references with the 6 months of delay. Additionally, a lower financial remuneration income was also booked in the period.

These results, despite the drop year-on-year, are in line with the plan for the first semester. As a consequence of the high seasonality of the non-mainland business, we expect performance acceleration in the second half, meeting our guidance of over full year of EBITDA above EUR 300 million.

Fixed cost remain flat year-on-year, which is notable considering activity increase required to accomplish our net for the commission and digitalization commitments.

Net CapEx amounted to EUR 213 million, most of it was in distribution where the digital transformation of our network continues to be implemented according to our business plan.

Moving now to Slide 18 on the liberalized business. EBITDA reach EUR 745 million or a 21% increase, driven by EUR 104 million improvement in gross margin and higher efficiency. In power, the increasing integrated margin as commented before was driven by higher OTC reference prices, the positive impact of the temporary suspension of the generation tax in the first quarter and higher nuclear production, partially compensating lower hydro availability and lower thermal spreads. Within [integrated] margin, Enel Green Power Spain had a positive contribution also partially thanks to the (inaudible) integration.

In gas, the already mentioned last year hedges with better price references versus the evolution of procurement costs triggered a 35% increase in gross margin to EUR 89 million.

Endesa X gross margin remained stable compared to last year. Fixed cost decreased around EUR 25 million, mainly due to lower O&M cost in the context of acceleration of growth investments mainly devoted to renewables for EUR 441 million.

Moving now to Slide 19 on the general evolution from EBITDA to net ordinary income. Starting from the EUR 1,894 million of EBITDA, D&A decreased by 6% to EUR 794 million. This is mainly due to the investment effort in digitalization and grid optimization, the update of the useful life in relation to the domestic coal plants, the acquisition of (inaudible) as well as the impact of IFRS 16 implementation which accounted for EUR 13 million.

Net financial results increased mainly due to the update of financial provision derived from the workforce restructuring plans and facilities dismantling which accounted for EUR 22 million together with adoption of IFRS 9 for EUR 6 million and IFRS 16 leases for EUR 2 million. Stripping out these effects and other minor adjustment, net financial results would have just increase around 5% due to the reduction in cost of debt that partially compensated that higher average gross debt.

Associates and Other item had a positive amount of EUR 10 million mainly for the sale of minority interest in some renewable assets closed during the quarter.

Income tax expenses amounted to EUR 232 million, 2% higher than in first half 2018 basically explained by higher profit before taxes. The effective tax rate of the period stands at 22.9%, slightly lower than the 23.2% recorded in first half '18. As a result, the net ordinary income increased 3% over the period.

Moving to Slide 20 on cash flow evolution from EBITDA to free cash flow. Cash flow from operating activities increased by 42% versus first half 2018, reaching EUR 907 million which has been almost sufficient to finance the important investment effort we are carrying out. This increase is due to the following effects: Higher EBITDA after provision paid of around EUR 50 million; working capital and others improved by 33% to EUR 705 million mainly due to the decrease of the negative net trade balance and lower inventories partially offset by lower cash-in from trade receivables and lower cash-in from non-mainland compensation.

Income tax decrease EUR 144 million mainly due to lower funds than in the first half 2018. Net financial expenses paid decreased 18%. The increase on noncash based CapEx by 37% as a consequence of development of renewal capacity and the digital transformation almost entirely financed by the cash flow from operation increase led to a free cash flow negative for EUR 84 million. These figures remains flat versus first half 2018.

Moving now to Slide 21 on the evolution of the net financial debt. Net debt amounts to EUR 6,795 million, EUR 839 million higher than the previous year once considering the first adoption accounting entry of IFRS 16 for EUR 186 million. The increase is due to free cash flow negative of EUR 44 million documented in the slide before and the payment of EUR 748 million in dividends corresponding mainly to the interim gross dividend against 2018 results amounting to EUR 0.70 per share.

The leverage ratio was 1.8x. The regulatory working capital increased by EUR 58 million up to EUR 868 million once considered EUR 238 million collected at the beginning of July. This amount is affected by delay in non-mainland settlements that accumulates a balance of around EUR 650 million.

Net debt by year-end is now expected to be around EUR 7.2 billion which is EUR 100 million lower than the guidance given in the first quarter as a result of a lower IFRS 16 impact on the new LNG tanker that is expected. Our gross debt structure shows an increase of the fixed income interest rate share of 4 percentage points versus 2018 closing as a consequence of our strategy aiming at taking advantage of the current context of historical minimum interest rates to close long-term fixing hedges.

Gross debt has an average life span of 5.3 years and an average cost of 1.8% at an historical lows which implies a further reduction versus 1.9% reported at the end of 2018.

Financial liquidity amounts to EUR 3,582 million out of [EUR 544 million] in cash and EUR 3,128 million available in credit lines. After the first green loan with EIB for EUR 335 million in the first quarter, we have also signed another green loan with Instituto de Credito Oficial for EUR 300 million, leveraging on our sustainable finance strategy.

Now moving on Slide 22, let me now hand over to Pepe for the final conclusion.

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [4]

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Thank you, Luca.

To close this presentation, I would like to conclude and underline some remarks in the performance of this first half. The resilience of our liberalized business despite the adverse market condition and coupled with a stable regulated business evolution underpin the positive EBITDA results and cash flow [regulation]. Our strong investment endeavors mainly in renewable capacity development enables us to confirm that the 879 megawatt of renewable capacity obtained under the 2017 auctions will be in operation by year-end or even earlier.

We continue to maintain extremely high standard of efficiency in this new investment cycle. Lastly, we are confident that this set of result will allow us to meet our 2019 announced guidance while keeping our commitment to sustainability and the United Nations sustainable development goals.

And ladies and gentlemen, this concludes our first half 2019 result presentation. Thank you very much for your attention and we are ready to take some questions.

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Questions and Answers

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Mar Martinez, Endesa, S.A. - Head of IR [1]

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Thank you, Pepe. We are now open to answer any question you may have.

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Operator [2]

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(Operator Instructions)

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Mar Martinez, Endesa, S.A. - Head of IR [3]

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The first question comes from Harry Wyburd from Bank of America Merrill Lynch.

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Harry Peter Wyburd, BofA Merrill Lynch, Research Division - VP and Junior Analyst [4]

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Three questions from me, please. So firstly on the regulatory proposals, I'm sure there'll be lots of questions on this today, but just a very narrow one. If you look at the proposals as they've been published, how do they compare to your expectations? I know that you have quite conservative expectations for the outcome here. So do you think it's fair that -- for us to assume that these are in line with what you had expected and if there was any improvement in the regulation, that would be upside to what's included in your guidance? And then secondly on gas, I was surprised at how good the numbers and the margins were in the second quarter. Obviously the pricing backdrop's quite challenging and I think most people assume that midstream gas and gas supply is under pressure in the remainder of the year. So if you could comment on why that second quarter was seemingly quite good, that would be very useful.

And then finally, just on the unitary margin and electricity, I know it's EUR 27.5 in the first half. I believe your budget for the year was about EUR 25. So you're a good EUR 2.5 or so ahead of that in the first half. Do you think that things are looking even better than they were in the first quarter? And then does that mean that your full year net income guidance now looks even more conservative, I guess if you add in the fact that gas has been good in the second quarter? And then looking forward to next year, obviously it was a difficult hydro year this year, but if hydro normalized next year, things would then look even better. So if you could just comment on where you think you are versus your full year net income guidance this year and next year given the strong unitary margin numbers?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [5]

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Okay. Thank you, Harry, and let me say with regard to the regulatory proposal, if this fill our expectation or not, let me say that it is just a preliminary proposal and partly consultation and therefore subject to attachments. So I would say that it is still very early to comment on the potential impact. In any case, let me say that this new regulation proposal brings some positive and some negative. The estimated impact being almost neutral.

The second thing with regard to the gas business and our performance in the second quarter of this year, I should say that the improvement is the better sales prices [referred] that we have had versus the evolution of the brand and we have indexes of our procurement costs. You know that we have -- as we have commented in previous results presentation, that the gas business is facing this year a very tough volatile scenario just because we have an excess of gas due to low Asian demand and mild temperatures in Europe resulting in a very low prices of LNG on the TTF index, generating and decoupling of [brand and] LNG TTF prices; nevertheless, we have been able to take this gross margin as I said just because of the evolution of our procurement costs and the sales price [roughly]. We think that we will continue doing some time in this very tough scenario, but we are convinced that this scenario will gradually improve in the future because prices will tend to rise but with huge volatility. In any case, we're expecting gas to be slightly below our target or our guidance for the year 2019. In terms of the unitary margin, you should take into account that in the EUR 27.5 per megawatt hour we have around EUR 40 million that comes from the 7% tax that we don't have in the first quarter. So that is something around EUR 26.5 and we're expecting around EUR 26 per megawatt hour at the end of the year.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [6]

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Yes, and to complement on that, basically, as Pepe said, we're expecting a EUR 26 per megawatt hour as an overall gen unitary integrated margin for 2019, which is slightly better than the EUR 25 that we have in our business plan, that obviously allow us to cover some shortfall one is gas that we have for the full year. So as far as net income, we confirm the 2019 guidance at 1.5. And for 2020, what we can comment that we are as far as the liberalized business already at 70% at quite healthy all-in price at EUR 76 per megawatt hour. So we have good visibility and at this point we can only confirm guidance also for 2020.

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Mar Martinez, Endesa, S.A. - Head of IR [7]

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Thank you, Luca. Next question comes from Alberto Gandolfi from Goldman Sachs.

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Alberto Gandolfi, Goldman Sachs Group Inc., Research Division - Head of European Utilities Research [8]

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It's Alberto Gandolfi, Goldman Sachs. I have 3 questions, please. The first one is a little bit clarity on your renewable pipeline on Slide 4. Out of the 1.8 gigawatts for 2020 and 2021 and the 6.9, can you please tell us how much you intend to develop via auctions and how much you intend to develop let's say merchants forward selling for your portfolio customers and maybe there's a third way, which could be through corporate PPAs. So I'm trying to understand the risk profile of this. And if you go contracted, if you can specify if you expect a different framework versus the existing one in Spain which merely provides a floor.

The second question is if you can comment on your potential interest for EDP hydro assets, what's the strategy? What's the philosophy? Is it really replacement of coal and medium-term nuclear you're thinking about here? How would you think about the evolution of the cash flow of these assets? If interested in the context of 200 gigawatt of renewable pipeline in Spain, so how you really think of it from a power price perspective?

And the last question, I'm slightly surprised by your comment about distribution. I forgot if you said revenues or returns lowest in Europe. Some of the lowest in Europe. And I think that you said lower remuneration for distribution assets in Europe. However, we have seen Sweden, U.K., Germany moving towards nominal returns of 3%, 3.5% and borrowing costs may be slightly different. But 5.6% looks quite healthy compared to borrowing rates in the industry between 0.2% and 1%. So I was wondering what am I missing in this framework?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [9]

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Okay. So I will give you comments on your question and I will give to Luca to answer explicitly. With regard to the EDP hydro asset, what I should say is that as you know, there is a formal process going on where we have been invited to participate. And the 31st of July is the day that has been set as the deadline for the presentation at the nonbinding offers. As with all the opportunities arising in the Iberian market, we are quite interested, of course. But always looking for a valid reason for our shareholders.

In terms of the distribution, this comment around the lowest remuneration in Europe, well first of all, let me say I don't agree with you that 3% or 3.5% is a good remuneration. Even more, what I think is that first of all, I agree with CNMC in the methodology of work. When I try to think about this work, I should say that the current -- previous rate used in this work is lower than the state bank. So I think that one of our comments on this proposal will be asking for a little increase in this remuneration. Looks healthy, as you have said, but we think that it is not enough. Now Luca will answer the questions.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [10]

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Yes, Alberto. So the first question regarding our pipeline we expect to build and on what work basis. I mean, as you know, in the plan we have beyond 2019 basically 1 gigawatt of renewables to be built in 2020 and 2021 in total. So 500 megawatts each. How much of this is merchant, when we go to the investment committee for this kind of builds, basically what we are assuming that maximum 40% of the energy produced by these plants will be merchant but the remaining 60% is changed in 2 ways, basically. A component to PPA, so to customer and there is enough demand by our let's say corporate customer base and the remaining by our, what we call, price-insensitive customers, which basically remains in our client base for more than 3 to 4 years, so that's basically the assumption. So you should assume 40% of the energy produced is the one that could be defined as merchant.

And just to clarify on the previous comment on distribution, what we are saying that the risk-free rate in the WACC calculation is a 297% which is slightly higher than the basically the cost of debt that was 63%. So therefore, what we deem appropriate is an alignment of these rates in the WACC calculation methodology for distribution.

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Mar Martinez, Endesa, S.A. - Head of IR [11]

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Thank you. We're going to the next question and we have from Javier Suarez from Mediobanca.

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Javier Suarez Hernandez, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [12]

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Three. First is coming back to the regulatory proposal, if you can elaborate a little bit more on your proposal to the regulator apart from the comment you make on a slight increase on remuneration. What other items in the regulatory formula can be -- in the regulatory framework can be improved from your point of view? And also a related question is which is your calculation of the clawback that Endesa may suffer in the period 2000 to 2025 under the current framework? That is the first question.

The second question is moving into the contribution from nonmainland generation during the first half 2019 it has been EUR 124 million. During the presentation, you mentioned EUR 300 million at a full GL contribution. If you can remind us what needs to happen for -- which is the reason for this underperformance in nonmainland generation during the first half? What needs to happen for you to reach the EUR 300 million by the year-end?

And then the second finance question is on the net debt evolution in Slide 20 and 21 I think during the presentation you mentioned that the slight improvement in the year-end target for that, EUR 7.2 billion. If you can elaborate on the number, the assumption of the regulatory working capital assumption including in that number. I think that by the end of the first half is EUR 1.1 billion, what are you assuming the regulatory work capital to be by the year-end?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [13]

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Thank you, Javier. Let me say to answer your first question, beyond the financial rate of return, I should say that our main comment is that the new methodology, in our opinion, must be applied for the investment expenses executed from January 1, 2020, not those incurred in 2019 and 2018. Any action carried out during the first regulated base in the current methodology must be recognized and regulated accordingly.

Lastly, let me say that perhaps, net warranty utilization investment, it with this methodology could be fixed in our opinion given that the proposal methodology doesn't include specific remuneration framework. That is more or less the main use and I would give the word to Luca to answer the questions.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [14]

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Yes, regarding the nonmainland basic evolution in the first half, let me comment on the factor I mentioned before. We have basically a gross margin EUR 45 million lower, mainly related to the fuel for EUR 19 million, 1-9; CO2 compensation for EUR 12 million; and as far as financial remuneration income lower for EUR 12 million. So in total, basically EUR 45 million lower in terms of gross margin, we expect an evolution in the second half because this business is seasonal and basically recover a bit of the full cost delay, we basically margin increased by almost EUR 50 million in the second part of the year. And containment in terms of cost, which basically brings to our EBITDA guidance of over EUR 200 million in the second part of the year. And for the third question on debt evolution, yes, we improved to EUR 7.2 billion our year-end guidance mainly on the lower impact to IFRS 16. The assumption of regulatory working capital is EUR 1.3 billion at the moment which is composed by EUR 1.1 billion in terms of nonmainland and about EUR 200 million for distribution.

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Mar Martinez, Endesa, S.A. - Head of IR [15]

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Next question comes from Anna Maria Scaglia from Morgan Stanley.

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Anna Maria Scaglia, Morgan Stanley, Research Division - Research Analyst [16]

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(technical difficulty)

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Mar Martinez, Endesa, S.A. - Head of IR [17]

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Probably we can move to the next question?

(technical difficulty)

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [18]

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market we are well interested, of course.

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Enrico Bartoli, MainFirst Bank AG, Research Division - MD [19]

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So you mentioned that you plan to invest around 40% of your pipeline in merchant assets. So if can you elaborate a bit on your view on the kind of returns that you think can be achieved through investments in merchant capacity compared to the one that can be achieved in the auctions? And also in terms of technology, you showed that most of your pipeline is in the solar technology. So if you can elaborate also on your expectations in terms of the return of this technology compared to the win.

Second question is related to Slide 12. The average revenue that you show in the first half is around EUR 68 per megawatt hour. You confirm your indication of EUR 73 for the full year. So can you provide us some details or why, I guess, you expect an acceleration in the average revenues in the second half of the year?

And the third one is related to the impact of CO2 that you had in the first half. If you can provide some details on your hedging policy for CO2 and the outlook that you can expect for the second half also for next year. If you expect that the shift of productions from coal to gas will continue and the possible impact on your margins.

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [20]

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Okay. Thank you, Enrico. I would say something about the CO2 impact in the (inaudible) and our policy and expectation for the future, and then perhaps some comments on the renewables and then I will give the word to Luca. Well, as we perfectly know, during the second quarter 2019 imported coal has been displaced from the (inaudible) by CCGTs. This change, in our opinion, is due to a combination of 3 factors: Very high CO2 prices; low gas prices as because of the excess of gas in the market and the removal of the gains in tax for CCGT seen at green sand and coal. All in all, what we think is this situation in the year 2019 will last up to the last quarter of the year in which prices perhaps will rise, yes, because of seasonal reasons. In any case, volumes and margins of the thermal coal, imported coal output will be reduced in this future. We don't know what would happen in the future, taking into account that once domestic coal power plants are closed, imported coal power plants should remain in the system for security of supply reasons until a new storage system, that is the large scale batteries, are available. And moreover, the Spanish energy and climate plan considers that up to 1.3 gigawatt of imported coal could be needed in the system in 2030 even though working very few hours. We expect these levels of CO2 prices in the future, that is something between the 25 and 30 in the future. And that means that the prices in the -- power prices in the wholesale market will be high aligned with our expectations. Also in the future in the next decade, we will have these prices of above 50 or around 50, and well, we have CO2 in the market and the impact is what I have said, and increasing the power prices and change in the changing or switching coal for gas.

In relation to the renewables, the EBITDA that we could obtain with merchant or auction, I would say the auctions, as far as I know, only give you a floor that is a guarantee. But if you believe that the prices are going to be aligned with our expectation, there is no any difference between the return, being merchant or being auctions.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [21]

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Yes, and to give you some numbers Enrico, we are expecting in terms of average equity levered IRR for the auction capacity, it's about 11%. And for the remaining basically gigawatt for 2020 and 2021, we're assuming 9%. Obviously that assumption as far as the power prices not only for the periods of the plan but also beyond them. As we said many times, we expect the power prices to remain around EUR 50 per megawatt hour up until 2030.

When it comes to basically the CO2 and just the hedging policy part of your question, I mean we don't have basically -- we don't take any position in CO2. We adjust CO2 as long as we are hedging the production from CO2 emission type of generation. So we don't take any position in that respect and we will continue to hedge this way.

And as far as your second question, how do you compare basically the final revenue numbers in the margin vis-à-vis what is the holding price at which we hedge our basically output. The difference or the deltas between the 2 where you have an all-in price are hedging higher than the final revenue margin is driven by the fact that we have basically some capacity or some generation that we provide into the market and some of the generation that we sell to B2B customers which are indexed to pool. And obviously the marginality of these 2 parts of the business lower the final revenue, basically income of integrated margin. So you always will have a differential -- major differential between what we see in terms of all-in hedged output and what is the final revenue number. And these has been ranging, I would say between EUR 2 and EUR 4 depending on the year.

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Mar Martinez, Endesa, S.A. - Head of IR [22]

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Thank you. We now had over to the Javier Garrido from JPMorgan.

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Javier Fernandez Garrido, JP Morgan Chase & Co, Research Division - Head of Utilities and Senior Analyst [23]

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Most of my questions has already been answered, so yes, 2 small follow-ups. The first one on the gas supply business, which is in your view going to be the impact of the commissioning of your first LNG tanker? What will be the impact on your numbers? If these will mean more flexibility going forward, but the cost of higher depreciation or am I missing something?

And then the second question is on the evolution of fixed cost in the regulized business, there has seen a significant decline in the second quarter. I think that Luca mentioned in the call the acceleration in investment in renewables was also linked to this factor. Should we see this as the impact of bigger capitalization of cost or is the acceleration in the reduction in fixed cost a sustainable trend?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [24]

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Okay, Javier. With regards to the gas business and the LNG tankers, you are right, that mainly the main advantage that we have with these LNG tanker is flexibility. That is very important for us. Flexibility is more than fulfilled we are going to have a slightly cost reduction, but that is not important. The important thing is the flexibility. Luca will answer the next question.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [25]

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Regarding fixed costs, I would say that the 2 drivers are 1, some delays of 50% to this reduction is driven by delays that we will recover during the year and another 50% is actually of real efficiency that we are now managing to basically achieve this year which would say a fixed cost evolution for the year is slightly better than what we expected at the beginning of the year. And this differential you're now taking into account a number which goes around EUR 30 million, I would say for the full year. Obviously, maintaining costs at these levels -- or reducing costs at these levels as I commented while we're building almost 100 megawatt hours of renewables this year is not an easy task, but obviously the management are fully committed to basically achieve this efficiency target for the full year.

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Mar Martinez, Endesa, S.A. - Head of IR [26]

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We have now Jorge Alonso from Société Générale.

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Jorge Alonso, Societe Generale Cross Asset Research - Research Analyst [27]

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Just a couple questions more, if I may. The first one is related to the regulatory working capital. Would it be possible to securitize it or it is not because of the legal issues or how it is built that you cannot securitize and get back the money from the system?

The second one is related to the nonmainland assets. With respect -- because honestly, I'm not sure here, the regulator to publish something impacting overview and the remuneration of the islands.

The third one is regarding the CCGT plants and displacing the core plants as you mentioned. I would like to understand how this impact the geothermal margins. And if that would mean that you may produce a little bit less and then you're open -- or your long position to the supply will be a little bit higher. If you are comfortable with that.

The final one please, it's about the political landscape. We have talked about some parameters entering the government. What's your view there and if you perceive any risk in terms of energy policy, if that may happen.

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [28]

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Okay, thank you, Jorge, and I will try to answer some of your questions. The first one, if you want with regard to the political landscape. Who knows? In any case, let me say that the new government, whatever it could be, in my opinion, should continue with the energy policies that were set out in June of 2018. So we don't expect any relevant, let's say relevant, changes neither in the flow nor in the plan with any government. That is what we really think.

In terms of the CCGT plants displacing coal, well thermal production will be reduced, and also thermal margin. And our long position will increase or could increase, let's say, in the next year about something below 5 terawatt hour something like that, with this very easy with the liquidity we have in the market just to cover this position. So we don't feel there is [rates] just to manage the situation and we feel comfortable with what we are doing up to now. And with regard to the nonmainland asset and then the regulation. Well as you know this regulation continue in the hands of the government, of the ministry. We would expect something before the end of the year. While the main theme could be the attachment of the financial return in line with what have happened with distribution, technician, et cetera. Nevertheless, we think that this business is a little bit more risky than let's say distribution. We would expect better remuneration tax. But in any way it's something we will discuss with the ministry in the next future.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [29]

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And Jorge regarding your first question about net working capital is something that is potentially securitizable. I mean, this -- we're working also with the regulators in order to make these swings basically smaller and we are working in [face]. And to be honest, these assets are really appealing to the financial markets for several additions. And second, being the largest operator in nonmainland, so I think this is something that we need to do with the regulator rather than with the financial markets.

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Mar Martinez, Endesa, S.A. - Head of IR [30]

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Next question comes from Meike Becker from Bernstein.

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Meike Alina Becker, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [31]

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I have 2. Looking at Slide #7 and the efficiencies and expectations target for 2021, you are well on track for distribution and also generation. But there's a little bit of a gap for enabling power and supply, so I was wondering what are the levels between today and 2021 which makes you comfortable that you can reach these cost to serve your customer supply and the fixed cost reduction in every part?

And the second question is about in the distribution network. On the one hand, in the long term, we are seeing a lot of need for investment in the network on the back of renewables and electrification of the industry. But RAB growth in the current plan is 0. So I'm wondering what will get us to the positive RAB growth and when can we expect it.

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [32]

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Well, Luca will answer.

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [33]

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Yes. First question regarding fixed cost evolution. The gap alternative power has between now and 2021 targets, I mean, already reducing, I would say, our fixed cost base by EUR 1 -- or EUR 1,000 per megawatt produced in a year in which we are putting down almost a gigawatt, I think is a big achievement. I mean between there and obviously 2021 scale will be the driver in terms of the reduction of cost for energy power having, let's say, more generation available from wind power.

And as far as supply, I mean, as you know, we are going through a full digitalization process. And in 2020, we have changing of all our systems both the front office and back-office system. So for 2021, obviously, the drop will be higher. And just to mention the system we're changing the CRM for B2B, the CRM for B2C, as well as basically the back office software which will go into a SAP model (inaudible) that obviously will drive efficiency further in the basically last year of the plan.

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Mar Martinez, Endesa, S.A. - Head of IR [34]

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Thank you. We have now Manuel Palomo from Exane BNP.

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Manuel Palomo, Exane BNP Paribas, Research Division - Analyst of Utilities [35]

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I just have a couple of questions. First question is on this nuclear tax one-off. Can you please elaborate on the reversal of the Catalan nuclear tax? And also share with us whether you foresee any other one-off positive or negative in 2019?

And second one, and sorry to insist on this point is regarding regulation. What do you think is the rationale for electricity distribution return to be [5 58] and to be lower than gas distribution [5 53]? When the energy transitioned rather than realizing electricity and investments are needed than in gas. Is this one of the reasons why you believe the electricity distribution return should be higher?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [36]

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Okay, Manuel, let me say you are right and I agree with you. Of course, I think that -- I don't want to really go against other businesses. But I really believe the remuneration of the power distribution should be higher than others. That is my opinion, I agree with you, and nothing more.

And in terms of the tax reversal -- nuclear tax reversal in the Catalan. Well, first of all I should say that this is unconstitutional. So I don't know what will happen in the future, but the real thing is that this kind of tax don't have any room in the tax framework that we have in Spain.

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Mar Martinez, Endesa, S.A. - Head of IR [37]

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We now have Jorge Guimarães from JB Capital.

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Jorge Guimarães, JB Capital Markets, Sociedad de Valores, S.A., Research Division - Analyst [38]

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I just have 2. Firstly, on the Hydro assets from EDP, would the possible acquisition be a replacement of other capacity to be developed in solar? Meaning if you buy these assets, you'll not develop 9 gigawatts, but less?

And second, still on the solar. Do you see the grid connection rules set out or the draft that's published by CNMC as a potential threat to your profitability objectives in this solar projects?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [39]

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Let me say with regard to that, hydro assets of EDP. First of all, we will see what happens in the future. Because as I have said, well, we are interested, but always looking for value creation for our shareholders so that means that we will see. In any case, this M&A operation would not replace older capacity that we have on our business plan.

With regard to the connections, well I would like to say that the drop low in sales is that in this case of fair competition at least the government could have the possibility to really go ahead with a different methodology, just as I have said, to fulfill with the objective of the -- for a transition.

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Mar Martinez, Endesa, S.A. - Head of IR [40]

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Okay. Next question is from Anna Maria Scaglia from Morgan Stanley.

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Anna Maria Scaglia, Morgan Stanley, Research Division - Research Analyst [41]

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Can you hear me now? Just a quick one on the gas business, you mentioned that part of the reason of the high margin this year is the fact that you edged forward and that the price required is lower. So would you -- what's your view, what would you see now for 2020 if you can comment?

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José Damián Bogas Gálvez, Endesa, S.A. - CEO & Executive Director [42]

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Anna Maria, you are right in what you have said. What happened is in the future, we will see. Today for the year 2020, we have hit around 53 of the forward sales that is something along on the 40 terawatt hour compared to the total output expected of 70-something terawatt hour. We are, as I have said, in a very tough and volatile market, I would say that we will try to do our best, at least we will try to do as successful as we have done up to date. But it is a risk and tough market as I have said, at least in this years until the year 2022 or something like that.

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Mar Martinez, Endesa, S.A. - Head of IR [43]

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Meike Becker from Bernstein.

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Meike Alina Becker, Sanford C. Bernstein & Co., LLC., Research Division - Research Analyst [44]

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So I'm coming back to electricity network. Considering the overall need to invest in it, what do you see the long term RAB growth potential for the electricity distribution network in Spain?

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Luca Passa, Endesa, S.A. - CFO and GM of Administration, Finance & Control [45]

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Meike, to comment on this question, I can only point you out what is actually in the national energy plan that foresees for distribution over the next 10 years, about EUR 20 billion of investments in order to accommodate basically both renewables basically increase terms of generation within the system as well as the electric vehicle mobility within the system. We currently have just slightly above 40% of market share, so that's basically will be our share in terms of these new investments in the distribution network. Obviously, in order to support the investments you need to have regulatory framework that I will say allow us to basically get at this speed in terms of investments.

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Mar Martinez, Endesa, S.A. - Head of IR [46]

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Okay, thank you. At this point, we are done with the questions received from the call and those received from the web has been tackled during the presentation. So just a reminder, the IR team will be available in case you have any further question. Thank you very much for your attention.