New Zealand Professional Investment Services Firm, Forsyth Barr

Forsyth Barr

New Zealand Professional Investment Services Firm

We are proud to be a New Zealand owned firm, with 21 offices throughout the country and over 300 employees. We assist personal, institutional and corporate clients providing a full range of investment services.

Forsyth Barr is a foundation New Zealand Exchange firm (NZX) and accredited market participant. We have been confirmed by the Financial Markets Authority as a Qualifying Financial Entity (QFE).

Research is the cornerstone of our advice. We have one of New Zealand's leading teams of analysts. Our global affiliations ensure comprehensive research coverage of all major investment markets.

Equity Bottom-Up

<h2>Vector</h2>
ComCom WAC<a target="_blank"></a>Cs Electricity Price
The Commerce Commission (ComCom) has reset Vector’s (VCT) maximum allowable electricity revenue -6% lower for the regulatory year to 31 March 2021. The price cut was expected in light of the low interest rate used to set the regulated weighted average cost of capital (WACC). Looking ahead, the key decisions for VCT are what it does with its dividend and whether it applies for a customised price path (CPP).
What’s changed?
<ul>
<li>Earnings: No change to near-term earnings</li>
<li>Target Price: Unchanged at $3.20</li>
<li>Rating: UNDERPERFORM rating retained</li>
</ul>
ComCom regulatory price reset in line with expectations
The ComCom’s starting price point for VCT’s regulated electricity revenue is slightly lower than the ComCom’s draft September 2019 calculation, with the main difference coming from a lower regulatory opex and capital allowance. The key point is that revenue will be ~-$25m lower in the year to 31 March 2021 relative to the prior year — in line with expectations.
VCT Board yet to determine dividend implications, CPP possible
VCT has again indicated that the Board “will review its dividend policy and approach to capital projects”. At the latest, an announcement regarding dividend policy will be made at VCT’s 1H20 result in February 2020.
Our assumption is that the Board will maintain dividend growth of +0.25cps per annum, but will move to partially impute the dividend to 70%. If the Board does not alter the dividend policy it risks a credit rating downgrade to BBB- as its credit metrics get very close to S&amp;P’s lower threshold boundary.
VCT has other decisions to make around whether it applies for a CPP and/or increase its up front capital contribution requirements from developers. VCT had been seeking a material increase to its capex allowance, however, the ComCom caps any capex allowance increase at +20% — meaning VCT’s capex allowance is -$189m (~-$38m per annum) below what VCT had been seeking. Applying for a CPP would allow VCT to seek a higher capex allowance, but comes with significant downside in the form of management distraction and there is no guarantee the ComCom will allow higher capex.
Potential uplift from higher market risk premium, but in five years
Last week the ComCom released its draft regulatory decision for fibre. In it, the ComCom’s WACC advisor recalculated the market risk premium (MRP), increasing his estimate to 7.5% from 7.0%. The electricity price reset uses the current MRP estimate of 7.0%, hence, there is upside potential at the next regulatory price reset (in five years). A 7.5% MRP adds ~+0.18% to VCT’s WACC (~+$10m to EBITDA). However, the draft fibre decision is undergoing consultation. There is a risk the draft decision does not stick, and/or when input methodologies are reset (in three years), the MRP estimate drops back to 7.0%.&nbsp;
<div class="content-highlight">
Investment View
Our rating is UNDERPERFORM. Whilst VCT offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.&nbsp;
</div>
Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185

Vector
ComCom WACCs Electricity Price
The Commerce Commission (ComCom) has reset Vector’s (VCT) maximum allowable electricity revenue -6% lower for the regulatory year to 31 March 2021. The price cut was expected in light of the low interest rate used to set the regulated weighted average cost of capital (WACC). Looking ahead, the key decisions for VCT are what it does with its dividend and whether it applies for a customised price path (CPP).
What’s changed?

Earnings: No change to near-term earnings
Target Price: Unchanged at $3.20
Rating: UNDERPERFORM rating retained

ComCom regulatory price reset in line with expectations
The ComCom’s starting price point for VCT’s regulated electricity revenue is slightly lower than the ComCom’s draft September 2019 calculation, with the main difference coming from a lower regulatory opex and capital allowance. The key point is that revenue will be ~-$25m lower in the year to 31 March 2021 relative to the prior year — in line with expectations.
VCT Board yet to determine dividend implications, CPP possible
VCT has again indicated that the Board “will review its dividend policy and approach to capital projects”. At the latest, an announcement regarding dividend policy will be made at VCT’s 1H20 result in February 2020.
Our assumption is that the Board will maintain dividend growth of +0.25cps per annum, but will move to partially impute the dividend to 70%. If the Board does not alter the dividend policy it risks a credit rating downgrade to BBB- as its credit metrics get very close to S&amp;P’s lower threshold boundary.
VCT has other decisions to make around whether it applies for a CPP and/or increase its up front capital contribution requirements from developers. VCT had been seeking a material increase to its capex allowance, however, the ComCom caps any capex allowance increase at +20% — meaning VCT’s capex allowance is -$189m (~-$38m per annum) below what VCT had been seeking. Applying for a CPP would allow VCT to seek a higher capex allowance, but comes with significant downside in the form of management distraction and there is no guarantee the ComCom will allow higher capex.
Potential uplift from higher market risk premium, but in five years
Last week the ComCom released its draft regulatory decision for fibre. In it, the ComCom’s WACC advisor recalculated the market risk premium (MRP), increasing his estimate to 7.5% from 7.0%. The electricity price reset uses the current MRP estimate of 7.0%, hence, there is upside potential at the next regulatory price reset (in five years). A 7.5% MRP adds ~+0.18% to VCT’s WACC (~+$10m to EBITDA). However, the draft fibre decision is undergoing consultation. There is a risk the draft decision does not stick, and/or when input methodologies are reset (in three years), the MRP estimate drops back to 7.0%.&nbsp;

Investment View
Our rating is UNDERPERFORM. Whilst VCT offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.&nbsp;

Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185

<h2>Vector</h2>
Imputing a Lower Gross Dividend — FY19 Result Review
Vector (VCT) produced a mixed FY19 result, with EBITDA up +3% to $486m. Two thirds of the growth was from an accounting change and there was a -$47m write-off of a recently acquired asset. As expected, VCT declared a fully imputed final dividend of 8.25cps, although we believe the dividend is under pressure due to the low interest rate environment.
What’s changed?
<ul>
<li>Earnings: FY20 EBITDA increased +$13m to $499m</li>
<li>Target Price: Target price unchanged at $3.20</li>
<li>Rating: UNDERPERFORM rating retained</li>
</ul>
Meter business the only real shining light in dull FY19 result
VCT’s metering business delivered EBITDA growth of +$12m and with accounting changes adding a further +$11m; putting into context the +$16m EBITDA growth VCT achieved in FY19. Gas Trading had a difficult year as VCT was impacted by the Pohokura gas outage and the Network division faced lower gas regulatory earnings and higher maintenance costs. However, the biggest disappointment was the E-Co Products business, acquired in early 2017. VCT has written down its book value -$47m, ~50% of the acquisition cost. Normalised NPAT of $130m was -$1m lower than the pcp, with higher depreciation costs offsetting the increase in EBITDA.
No formal FY20 guidance due to regulatory uncertainty
With the Commerce Commission’s (ComCom) final electricity price reset decision due late November, VCT has not provided earnings or dividend guidance. The low interest rate environment is problematic for VCT given its importance in the regulatory WACC and therefore electricity price reset decision. Other important factors in the price reset are the opex and capex allowances that VCT will be given.
Fully imputed dividend may become a thing of the past
VCT again said its dividend policy will be reviewed following the ComCom decision. However, it also reiterated the importance of maintaining its BBB credit rating. After further consideration, we believe VCT will continue to grow its headline dividend, but will no longer fully impute the dividend. At year end VCT had prepaid $105m of tax and it is questionable how long VCT can keep prepaying tax in order to pay a fully imputed dividend. We have lifted our FY20 dividend forecast +0.25cps to 16.75cps, but assume it will be 70% imputed.
Positive earnings forecast changes, but capex is increasing too
We have lifted our FY20 EBITDA forecast +$13m to $499m, mainly due to differences in the FY19 result flowing into later years. However, there is little change to our valuation, as we have also lifted our capex assumption (+11%) as the metering business looks to grow faster than previously forecast.
<div class="content-highlight">
Investment View
Our rating is UNDERPERFORM. Whilst Vector (VCT) offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.
</div>
Andrew Harvey-Green
andrew.harvey-green@forsythbarr.co.nz
+64 4 495 8185

Vector
Imputing a Lower Gross Dividend — FY19 Result Review
Vector (VCT) produced a mixed FY19 result, with EBITDA up +3% to $486m. Two thirds of the growth was from an accounting change and there was a -$47m write-off of a recently acquired asset. As expected, VCT declared a fully imputed final dividend of 8.25cps, although we believe the dividend is under pressure due to the low interest rate environment.
What’s changed?

Earnings: FY20 EBITDA increased +$13m to $499m
Target Price: Target price unchanged at $3.20
Rating: UNDERPERFORM rating retained

Meter business the only real shining light in dull FY19 result
VCT’s metering business delivered EBITDA growth of +$12m and with accounting changes adding a further +$11m; putting into context the +$16m EBITDA growth VCT achieved in FY19. Gas Trading had a difficult year as VCT was impacted by the Pohokura gas outage and the Network division faced lower gas regulatory earnings and higher maintenance costs. However, the biggest disappointment was the E-Co Products business, acquired in early 2017. VCT has written down its book value -$47m, ~50% of the acquisition cost. Normalised NPAT of $130m was -$1m lower than the pcp, with higher depreciation costs offsetting the increase in EBITDA.
No formal FY20 guidance due to regulatory uncertainty
With the Commerce Commission’s (ComCom) final electricity price reset decision due late November, VCT has not provided earnings or dividend guidance. The low interest rate environment is problematic for VCT given its importance in the regulatory WACC and therefore electricity price reset decision. Other important factors in the price reset are the opex and capex allowances that VCT will be given.
Fully imputed dividend may become a thing of the past
VCT again said its dividend policy will be reviewed following the ComCom decision. However, it also reiterated the importance of maintaining its BBB credit rating. After further consideration, we believe VCT will continue to grow its headline dividend, but will no longer fully impute the dividend. At year end VCT had prepaid $105m of tax and it is questionable how long VCT can keep prepaying tax in order to pay a fully imputed dividend. We have lifted our FY20 dividend forecast +0.25cps to 16.75cps, but assume it will be 70% imputed.
Positive earnings forecast changes, but capex is increasing too
We have lifted our FY20 EBITDA forecast +$13m to $499m, mainly due to differences in the FY19 result flowing into later years. However, there is little change to our valuation, as we have also lifted our capex assumption (+11%) as the metering business looks to grow faster than previously forecast.

Investment View
Our rating is UNDERPERFORM. Whilst Vector (VCT) offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.

Andrew Harvey-Green
andrew.harvey-green@forsythbarr.co.nz
+64 4 495 8185

Vector: Imputing a Lower Gross Dividend — FY19 Result Review

New Zealand

Vector Limited is an energy infrastructure company in New Zealand that provides electricity and gas transmission and distribution along with metering.  The Company is also a wholesaler of LPG and natural gas.  Vector also delivers broadband voice and data communications in the Auckland and Wellington regions.

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Vector Ltd (VCT NZ)

Vector: ComCom WACCs Electricity Price

Vector ComCom WACCs Electricity Price The Commerce Commission (ComCom) has reset Vector’s (VCT) maximum allowable electricity revenue -6% lower for...

Forsyth Barr

Vector: Imputing a Lower Gross Dividend — FY19 Result Review

Vector Imputing a Lower Gross Dividend — FY19 Result Review Vector (VCT) produced a mixed FY19 result, with EBITDA up +3% to $486m. Two thirds of...

Forsyth Barr

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