New Zealand Professional Investment Services Firm

Forsyth Barr

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.

New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Electricity Sector<br>Is Electricity Offering Value Again?</h2>
<p></p>
<div id="m_859133201954141791iubdj-2-2">
<p>In our view, not yet. Whilst electricity share prices are generally&nbsp;down -10% to -15% since the end of May 2021 (vs. the S&amp;P NZ50G lifting +3% over the same time), valuation metrics are still elevated and we still see downside risk for the sector. Current sector multiples and dividend yields are ~+15% to +20% greater/lower than December 2018 when interest rates (as measured by the 10-year swap rate) were last at current levels. We have analysed sector valuations now vs. December 2018 and conclude there is further downside risk. We have reassessed our market-based valuations of the generator/retailers dropping the target prices of four companies between -2.5% and -8.8% and downgrading our Genesis Energy (GNE) rating to NEUTRAL given concerns with earnings at the end of the decade.</p>
</div>
<div>
<h3>Whilst rising interest rates have lead the sector lower, we think there is more to go</h3>
</div>
<div id="m_859133201954141791ikqui-2-2">
<p>The lift in interest rates has partially had the expected effect on sector valuations. Multiples are trending down and dividend yields trending up following the +220bp increase in the 10-year swap rate over the past 13-months. However, we calculate that the average Yr3 sector EV/EBITDAF multiple (which takes out near-term growth differences) is +15% higher now than December 2018 when the&nbsp;10-year swap&nbsp;rate&nbsp;was&nbsp;last around 2.7%. Whilst there are factors explaining some of the difference, we do not believe they explain all of the uplift.</p>
</div>
<div>
<h3>Long-term earnings growth outlook no different to 2018, with wholesale electricity&nbsp;price&nbsp;backwardation&nbsp;a headwind</h3>
</div>
<div id="m_859133201954141791i64bs-2-2">
<p>There are two main factors that could explain higher multiples, a declining equity risk premium and better growth prospects. Our analysis indicates a declining trend in the spread between interest rates and dividends. Six&nbsp;years ago the spread was ~6.5%, the trend line is now down to ~4%, and the fact the average spread is below the&nbsp;trendline&nbsp;points to more share price downside risk. In addition, with interest rates rising, we expect&nbsp;investors forced into the equity market to find yield will retreat back to the fixed interest market (subject to supply), placing upward pressure on the spread. Our growth forecasts indicate that post-FY24&nbsp;earnings growth is likely muted, with wholesale electricity prices likely to be materially lower than current levels.</p>
</div>
<div>
<h3>Revised market valuation approach</h3>
</div>
<div>
<p>In recalculating our target prices&nbsp;we have revised our market multiple and dividend yield valuation approaches,&nbsp;focussing&nbsp;on underlying earnings after near-term growth projects have been completed i.e. FY24 as opposed to near-term earnings. In addition, we now use EV/EBITDAF less&nbsp;capex&nbsp;as one of the market multiple approaches as it better matches free cash flow (the other is adjusted NPAT). The greatest changes relate to GNE. We have increasing concerns about its long-term earnings as its thermal generation is used less. Whilst the use of&nbsp;offtake&nbsp;agreements will ensure GNE is able to service its retail base, we believe it also increases earnings volatility.</p>
</div>

Electricity Sector Is Electricity Offering Value Again?


In our view, not yet. Whilst electricity share prices are generally&nbsp;down -10% to -15% since the end of May 2021 (vs. the S&amp;P NZ50G lifting +3% over the same time), valuation metrics are still elevated and we still see downside risk for the sector. Current sector multiples and dividend yields are ~+15% to +20% greater/lower than December 2018 when interest rates (as measured by the 10-year swap rate) were last at current levels. We have analysed sector valuations now vs. December 2018 and conclude there is further downside risk. We have reassessed our market-based valuations of the generator/retailers dropping the target prices of four companies between -2.5% and -8.8% and downgrading our Genesis Energy (GNE) rating to NEUTRAL given concerns with earnings at the end of the decade.


Whilst rising interest rates have lead the sector lower, we think there is more to go


The lift in interest rates has partially had the expected effect on sector valuations. Multiples are trending down and dividend yields trending up following the +220bp increase in the 10-year swap rate over the past 13-months. However, we calculate that the average Yr3 sector EV/EBITDAF multiple (which takes out near-term growth differences) is +15% higher now than December 2018 when the&nbsp;10-year swap&nbsp;rate&nbsp;was&nbsp;last around 2.7%. Whilst there are factors explaining some of the difference, we do not believe they explain all of the uplift.


Long-term earnings growth outlook no different to 2018, with wholesale electricity&nbsp;price&nbsp;backwardation&nbsp;a headwind


There are two main factors that could explain higher multiples, a declining equity risk premium and better growth prospects. Our analysis indicates a declining trend in the spread between interest rates and dividends. Six&nbsp;years ago the spread was ~6.5%, the trend line is now down to ~4%, and the fact the average spread is below the&nbsp;trendline&nbsp;points to more share price downside risk. In addition, with interest rates rising, we expect&nbsp;investors forced into the equity market to find yield will retreat back to the fixed interest market (subject to supply), placing upward pressure on the spread. Our growth forecasts indicate that post-FY24&nbsp;earnings growth is likely muted, with wholesale electricity prices likely to be materially lower than current levels.


Revised market valuation approach


In recalculating our target prices&nbsp;we have revised our market multiple and dividend yield valuation approaches,&nbsp;focussing&nbsp;on underlying earnings after near-term growth projects have been completed i.e. FY24 as opposed to near-term earnings. In addition, we now use EV/EBITDAF less&nbsp;capex&nbsp;as one of the market multiple approaches as it better matches free cash flow (the other is adjusted NPAT). The greatest changes relate to GNE. We have increasing concerns about its long-term earnings as its thermal generation is used less. Whilst the use of&nbsp;offtake&nbsp;agreements will ensure GNE is able to service its retail base, we believe it also increases earnings volatility.


Electricity Sector: Is Electricity Offering Value Again?