Current Report No. 40/2016

Current Report No. 40/2016

Date of preparation: 15 November 2016

Subject: Adoption of the ENERGA Group’s Strategy for 2016-2025

Legal basis: Article 17 Section 1 of the Market Abuse Regulation - confidential information

The Management Board of ENERGA SA (“Company”) hereby reports that on 15 November 2016 the Company’s Supervisory Board adopted a resolution to approve the following documents: “Strategy of the ENERGA Group for 2016-2025” (“Strategy”) and “Long-Term Strategic Investments Plan of the ENERGA Group for 2016–2025”.

Grounds for updating the Group’s Strategy

The recent decline in profitability throughout the power sector has forced leading European and Polish utility groups to revise their strategies. The conduct of business activity based on the current business model would result, in the medium term, in deteriorated financial performance and lower valuation of utility companies. Efforts aimed at maintaining or improving the financial results will require adaptation to new trends: development of distributed generation and renewable energy sources (RES), attempts at improving energy efficiency and emergence of new technologies, players and business models in the market. Market trends observed throughout Europe and in Poland will be reflected in the ENERGA Group’s financial results. Accordingly, it is necessary to adjust the ENERGA Group’s business model to the new challenges.

Strategic objectives and programs

In order to solidify the position of the ENERGA Group as an innovative customer-oriented utility group and taking into account a stable business foundation based on predictable regulations, the Strategy assumes two areas of business development and value creation, namely Infrastructure and Customer, within which the following strategic objectives and programs of the ENERGA Group have been identified:

Objective 1. Developing modern energy infrastructure in a way that makes it possible to have a stable revenue base, dependent mainly on the quality of services provided rather than on typical market drivers. The infrastructure will respond to the future requirements of the Polish electrical power system, and its development will enable to keep a balance between the interests of all stakeholders of the ENERGA Group.

Program 1 / Expansion of a smart and reliable electricity distribution grid affording opportunities to market energy storage and local management services

Program 2 / Development of infrastructure for broadband web access

Program 3 / Utilizing regulations to stabilize revenues in the Capacity Market and tariffs on heat

Program 4 / Maintaining a solid position in the RES area through the execution of (1) a hydro power plant construction project as part of the development of the second step dam on the Vistula River and (2) other RES-related projects

Objective 2. Customer-focused business model facilitating effective customer value management based on a coherent product and service offering.

Program 5 / Rolling out a new customer-oriented business model and developing new business areas – the program will result in the creation of approx. 100 new products dedicated to three customer segments: individual customers, business customers and local government and public administration units.

The EBITDA target is an increase to PLN 2.4 billion in 2020 and to PLN 3.0 billion in 2025. The target value of the ENERGA Group’s EBITDA will be driven in large by PLN 100 million in revenues from new products and services in 2020 and PLN 300 million in 2025 and by the efficiency improvement program expected to generate PLN 130 million in 2020 and PLN 150 million in 2025.

The detailed programs will be adopted by the Energa SA Management Board and will be monitored on an ongoing basis for the effectiveness of achievement of the strategic objectives. Specific targets will be set as part of the preparation of implementation plans. Oversight will be exercised by way of strategic controlling using the ENERGA Group’s Management by Objectives system.

Dividend

Dividend policy will be adapted to the financial needs of the investment process which assumes the cessation of key spending items by 2023. At the same time, the provisions included in the Company’s Prospectus approved by the Polish Financial Supervision Authority on 15 November 2013 regarding declarative dividend payments have gone out of date.

Investment plan

Total expenditures on core and non-core investments of the ENERGA Group planned for 2016-2025 as part of the implementation the Strategy are approx. PLN 20.6* billion, of which PLN 9.5 billion is expected to be spent in 2016-2020.

In the Distribution Segment, expenditures of approx. PLN 13.0 billion will be incurred in the period of 2016-2025. The investments will focus predominantly on the construction and modernization of the grid in connection with: improving the reliability of supply (PLN 5.0 million), connecting customers (PLN 4.5 million) and increasing flows in the high-voltage grid and connecting new electricity sources (PLN 1.2 billion). Moreover, expenditures on smart metering and other elements of the roll-out of smart grids will amount to PLN 1.2 billion. Other expenditures in the Distribution Segment will reach PLN 1.1 billion. The expected result of the implementation of the investment program is to achieve 100% of remotely operated metering systems (AMI meters) by 2025 and to meet the requirements of the quality tariff in terms of SAIDI, SAIFI and connection times.

Earmarked for the Generation Segment is approx. PLN 6.1 billion for 2016-2025, including the following amounts in each subsegment: PLN 4.1 billion for must-run power plants, PLN 1.5 billion for RES and PLN 0.5 billion for CHP.  The primary investment is the construction of a modern Ostrołęka C power plant with a capacity of approx. 1,000 MWe. The baseline scenario assumes that the ENERGA Group will cover 50% of expenditures and that the remaining expenditures will be incurred by a partner or several partners. The ENERGA Group also intends to take advantage of the opportunities offered by the planned Capacity Market. In the RES area, the main long-term investment is the construction of a hydro power plant with a capacity of approx. 80 MWe as part of the second step dam on the Vistula River, assuming that the construction permit will be obtained by 2020. The planned expenditures pertain exclusively to the power generation part of the facility. Other RES projects are expected to contribute to an increase in capacity by 50 MWe in 2020.

To the Sales Segment, expenditures in the amount of PLN 0.7 billion have been allocated. They entail predominantly investments in developing IT tools and investments in street lighting.

Additionally included are expenditures on investments associated with the development of new areas and activities, ancillary activities supporting primary processes and additional development investments in the total amount of PLN 0.7 billion.

It may be impossible to achieve the set objectives exclusively by means of organic growth. Accordingly, the successful implementation of the Strategy will depend on the achievements in the mergers and acquisitions area. In this context, the Group will focus its activities on Poland but allows the possibility of cross-border investments in order to gain access to specific know-how (also in respect of business models). Moreover, the Group will constantly monitor the market to identify potential acquisition targets in the area of the ENERGA Group’s value chain.

All of the ENERGA Group’s investment endeavors must meet the minimum investment attractiveness criterion, hence the Group will focus mainly on profitable investments that will help ensure its financial stability. An important indicator to keep in mind for the Energa SA Management Board during the implementation of the actions set out in the Strategy will be the maximum assumed level of net debt/EBITDA assumed at 3.5 and the maintenance of the current investment rating. The ENERGA Group intends to acquire strategic partners for the execution of its largest projects.

*Minor difference in the total due to rounding.