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>S&amp;P Clean Energy Index Consultation&nbsp;Threepeat</h2>
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<p>The upshot of S&amp;P's third go at changing its Global Clean Energy (GCE) Index rules, (despite seemingly finalising new rules mid-February), is a probable further reduction of the GCE Index weights of Contact Energy (CEN) and Meridian Energy (MEL).&nbsp; We estimate that under the proposed changes the&nbsp;ETFs&nbsp;that track the index will be required to sell between 72m–78m shares in CEN (~9% of free float) and between 100m–109m shares in MEL (~8% of free float). The exact amount will depend on the size and liquidity of new GCE Index constituents. The consultation doesn't mention a change to the US$3m six month MDVT (median daily traded value) entry threshold, meaning we expect Mercury (MCY) will still miss out on inclusion.</p>
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<h3>New proposals will increase the number of GCE Index constituents, diluting CEN and MEL further</h3>
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<p>The key proposed change impacting CEN and MEL is the increased target constituent count of 100, which will dilute MEL and CEN's weightings. To enable more constituents, S&amp;P is proposing to lower the "clean energy" requirement, allowing companies with a "significant clean energy exposure" to enter the GCE Index. Currently there are 30 GCE constituents. If S&amp;P applied the proposed rules at the October 2020 rebalance there would be 68 constituents, meaning as more companies meet the criteria the constituent count will increase towards 100 over time. A comparison of the current rules, the Feb-21 rule changes and the latest proposal are detailed in Figure 2.</p>
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<h3>Proposed rules increase the black box element of the GCE Index</h3>
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<p>It is harder to estimate the potential impact on CEN and MEL from the&nbsp;proposed rule changes, although there will extra ETF selling. It is unclear how S&amp;P assesses the "clean energy" aspect of constituents. With a lower clean energy threshold required to enter the GCE Index, it is possible some very large companies will now enter. Large, liquid companies entering the GCE Index will dilute CEN and&nbsp;MEL the most. The current largest constituent has a free float market cap of US$35b, whilst the median is US$3.5b of the 30 constituents&nbsp;(CEN is US$3.7b and MEL US$4.8b). In addition, liquidity plays a bigger role than it used to and with MEL (US$8.9m) and CEN (US$7.9m) MDVT liquidity well below the median of current constituents (US$36m), their respective GCE Index weightings are going to be much lower than in the past.</p>
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<h3>CEN offers great value, MEL still looks expensive</h3>
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<p>Whilst there is short-term downside risk to CEN, we see good value at current levels. It is trading on an FY21 gross dividend yield of 6.9% (which we expect to grow in coming years) and an FY22 EV/EBITDAF 11.9x. In comparison MEL's gross dividend yield is 4.2% and FY22 EV/EBITDAF 20.6x. Our CEN rating is OUTPERFORM and our MEL rating is UNDERPERFORM.</p>
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<div><strong>Andrew Harvey-Green</strong></div>
<div><a href="mailto:andrew.harvey-green@forsythbarr.co.nz" target="_blank" rel="noopener">andrew.harvey-green@<wbr>forsythbarr.co.nz</a></div>
<div>+64 4 495 8185</div>
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<div><strong>Scott Anderson</strong></div>
<div><a href="mailto:scott.anderson@forsythbarr.co.nz" target="_blank" rel="noopener">scott.anderson@forsythbarr.co.<wbr>nz</a></div>
<div>+64 4 914 2219</div>
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Electricity Sector S&amp;P Clean Energy Index Consultation&nbsp;Threepeat


The upshot of S&amp;P's third go at changing its Global Clean Energy (GCE) Index rules, (despite seemingly finalising new rules mid-February), is a probable further reduction of the GCE Index weights of Contact Energy (CEN) and Meridian Energy (MEL).&nbsp; We estimate that under the proposed changes the&nbsp;ETFs&nbsp;that track the index will be required to sell between 72m–78m shares in CEN (~9% of free float) and between 100m–109m shares in MEL (~8% of free float). The exact amount will depend on the size and liquidity of new GCE Index constituents. The consultation doesn't mention a change to the US$3m six month MDVT (median daily traded value) entry threshold, meaning we expect Mercury (MCY) will still miss out on inclusion.



New proposals will increase the number of GCE Index constituents, diluting CEN and MEL further


The key proposed change impacting CEN and MEL is the increased target constituent count of 100, which will dilute MEL and CEN's weightings. To enable more constituents, S&amp;P is proposing to lower the "clean energy" requirement, allowing companies with a "significant clean energy exposure" to enter the GCE Index. Currently there are 30 GCE constituents. If S&amp;P applied the proposed rules at the October 2020 rebalance there would be 68 constituents, meaning as more companies meet the criteria the constituent count will increase towards 100 over time. A comparison of the current rules, the Feb-21 rule changes and the latest proposal are detailed in Figure 2.


Proposed rules increase the black box element of the GCE Index


It is harder to estimate the potential impact on CEN and MEL from the&nbsp;proposed rule changes, although there will extra ETF selling. It is unclear how S&amp;P assesses the "clean energy" aspect of constituents. With a lower clean energy threshold required to enter the GCE Index, it is possible some very large companies will now enter. Large, liquid companies entering the GCE Index will dilute CEN and&nbsp;MEL the most. The current largest constituent has a free float market cap of US$35b, whilst the median is US$3.5b of the 30 constituents&nbsp;(CEN is US$3.7b and MEL US$4.8b). In addition, liquidity plays a bigger role than it used to and with MEL (US$8.9m) and CEN (US$7.9m) MDVT liquidity well below the median of current constituents (US$36m), their respective GCE Index weightings are going to be much lower than in the past.


CEN offers great value, MEL still looks expensive


Whilst there is short-term downside risk to CEN, we see good value at current levels. It is trading on an FY21 gross dividend yield of 6.9% (which we expect to grow in coming years) and an FY22 EV/EBITDAF 11.9x. In comparison MEL's gross dividend yield is 4.2% and FY22 EV/EBITDAF 20.6x. Our CEN rating is OUTPERFORM and our MEL rating is UNDERPERFORM.



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





Scott Anderson
scott.anderson@forsythbarr.co.nz
+64 4 914 2219



Electricity Sector: S&P Clean Energy Index Consultation Threepeat