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><a target="_blank">Electricity Sector</a></h2>
Tiwai Transmission Cure to Take Time
We are upgrading one notch the rating of all of the four large generator/retailers. Contact Energy (CEN) and Genesis Energy (GNE) are upgraded to OUTPERFORM, Mercury (MCY) and Meridian Energy (MEL) are upgraded to NEUTRAL. The driver of the rating changes has been the significant market reaction to Rio Tinto’s (RIO) announcement that it is undertaking a strategic review and our view that the risk of closure is small (less than 10%).
Modest target price changes, with MEL and CEN to take a hit regardless of the outcome of negotiations
We have lowered our target prices between -0.4% and -3.3% for the risk associated with NZAS closing. The changes reflect:
<ul>
<li>A likely cut in earnings to MEL (-$13.0m) and CEN (-$4.5m) as we expect them to offer a lower price to NZAS, which will be accepted. We do not expect the other generator/retailers to offer a price reduction.</li>
<li>Lower ASX future electricity prices. ASX futures have fallen modestly reflecting a combination of closure risk and expected lower wholesale prices if closure occurs.</li>
<li>Modest value adjustment for residual factors, risk weighted to 20%.</li>
</ul>
The share price reaction following the RIO announcement has been -12%, -14% and -15% for MCY, CEN and MEL respectively. Whilst MSCI speculation is also a factor, in our view the share price movements are overdone, either creating a buying opportunity or reducing the premium the stocks had been trading at.
Figure 1. Target price and rating changes
<table class="table table-striped">
<thead>
<tr>
<td style="width: 38.85pt;"></td>
<td colspan="3" style="width: 109.3pt;">
Target Price
</td>
<td colspan="2" style="width: 128.3pt;">
Rating
</td>
<td style="width: 25.15pt;"></td>
</tr>
<tr>
<td style="width: 38.85pt;"></td>
<td style="width: 36.4pt;">
Old
</td>
<td style="width: 36.45pt;">
New
</td>
<td style="width: 36.45pt;">
% Chg
</td>
<td style="width: 64.15pt;">
Old
</td>
<td style="width: 64.15pt;">
New
</td>
<td style="width: 25.15pt;">
Chg
</td>
</tr>
</thead>
<tbody>
<tr>
<td style="width: 38.85pt;">
CEN
</td>
<td style="width: 36.4pt;">
$8.22
</td>
<td style="width: 36.45pt;">
$8.03
</td>
<td style="width: 36.45pt;">
-2.3%
</td>
<td style="width: 64.15pt;">
NEUTRAL
</td>
<td style="width: 64.15pt;">
OUTPERFORM
</td>
<td style="width: 25.15pt;">
▲
</td>
</tr>
<tr>
<td style="width: 38.85pt;">
GNE
</td>
<td style="width: 36.4pt;">
$3.28
</td>
<td style="width: 36.45pt;">
$3.23
</td>
<td style="width: 36.45pt;">
-1.5%
</td>
<td style="width: 64.15pt;">
NEUTRAL
</td>
<td style="width: 64.15pt;">
OUTPERFORM
</td>
<td style="width: 25.15pt;">
▲
</td>
</tr>
<tr>
<td style="width: 38.85pt;">
MCY
</td>
<td style="width: 36.4pt;">
$4.55
</td>
<td style="width: 36.45pt;">
$4.53
</td>
<td style="width: 36.45pt;">
-0.4%
</td>
<td style="width: 64.15pt;">
UNDERPERFORM
</td>
<td style="width: 64.15pt;">
NEUTRAL
</td>
<td style="width: 25.15pt;">
▲
</td>
</tr>
<tr>
<td style="width: 38.85pt;">
MEL
</td>
<td style="width: 36.4pt;">
$4.25
</td>
<td style="width: 36.45pt;">
$4.11
</td>
<td style="width: 36.45pt;">
-3.3%
</td>
<td style="width: 64.15pt;">
UNDERPERFORM
</td>
<td style="width: 64.15pt;">
NEUTRAL
</td>
<td style="width: 25.15pt;">
▲
</td>
</tr>
</tbody>
</table>
Source: Forsyth Barr analysis
Closer look at transmission issues
A key issue for MEL and CEN is how quickly can transmission constraints be relieved. If NZAS closes, we estimate 1/3 of hydro generation that was otherwise going to the smelter will be spilt. Transpower’s Lower South Island grid upgrade will take ~3 years to complete and during that time CEN and MEL will be the worst affected. Eliminating constraints further north is likely to take longer as Transpower has yet to get regulatory approval for those upgrades.
Further detail on the transmission issues and constraints are noted in the body of the report.
<div class="content-highlight">
Investment View
The share price reaction to the potential closure of NZAS has created buying opportunities in the electricity sector. We believe the risk of closure is low (less than 10%) and that CEN, GNE and Trustpower (TPW) all offer good value at present (OUTPERFORM). We are NEUTRAL on MCY and MEL.
</div>
Andrew Harvey-Green
<a target="_blank">andrew.harvey-green@forsythbarr.co.nz</a>
<a target="_blank">+64 4 495 8185</a>

Electricity Sector
Tiwai Transmission Cure to Take Time
We are upgrading one notch the rating of all of the four large generator/retailers. Contact Energy (CEN) and Genesis Energy (GNE) are upgraded to OUTPERFORM, Mercury (MCY) and Meridian Energy (MEL) are upgraded to NEUTRAL. The driver of the rating changes has been the significant market reaction to Rio Tinto’s (RIO) announcement that it is undertaking a strategic review and our view that the risk of closure is small (less than 10%).
Modest target price changes, with MEL and CEN to take a hit regardless of the outcome of negotiations
We have lowered our target prices between -0.4% and -3.3% for the risk associated with NZAS closing. The changes reflect:

A likely cut in earnings to MEL (-$13.0m) and CEN (-$4.5m) as we expect them to offer a lower price to NZAS, which will be accepted. We do not expect the other generator/retailers to offer a price reduction.
Lower ASX future electricity prices. ASX futures have fallen modestly reflecting a combination of closure risk and expected lower wholesale prices if closure occurs.
Modest value adjustment for residual factors, risk weighted to 20%.

The share price reaction following the RIO announcement has been -12%, -14% and -15% for MCY, CEN and MEL respectively. Whilst MSCI speculation is also a factor, in our view the share price movements are overdone, either creating a buying opportunity or reducing the premium the stocks had been trading at.
Figure 1. Target price and rating changes





Target Price


Rating






Old


New


% Chg


Old


New


Chg






CEN


$8.22


$8.03


-2.3%


NEUTRAL


OUTPERFORM


▲




GNE


$3.28


$3.23


-1.5%


NEUTRAL


OUTPERFORM


▲




MCY


$4.55


$4.53


-0.4%


UNDERPERFORM


NEUTRAL


▲




MEL


$4.25


$4.11


-3.3%


UNDERPERFORM


NEUTRAL


▲




Source: Forsyth Barr analysis
Closer look at transmission issues
A key issue for MEL and CEN is how quickly can transmission constraints be relieved. If NZAS closes, we estimate 1/3 of hydro generation that was otherwise going to the smelter will be spilt. Transpower’s Lower South Island grid upgrade will take ~3 years to complete and during that time CEN and MEL will be the worst affected. Eliminating constraints further north is likely to take longer as Transpower has yet to get regulatory approval for those upgrades.
Further detail on the transmission issues and constraints are noted in the body of the report.

Investment View
The share price reaction to the potential closure of NZAS has created buying opportunities in the electricity sector. We believe the risk of closure is low (less than 10%) and that CEN, GNE and Trustpower (TPW) all offer good value at present (OUTPERFORM). We are NEUTRAL on MCY and MEL.

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

Electricity Sector: Tiwai Transmission Cure to Take Time