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>Mercury<br>It Hurts Being Caught Short</h2>
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<p><strong>UNDERPERFORM</strong></p>
<p>Mercury (MCY) has downgraded FY21 guidance -NZ$60m to NZ$460m, which is greater than we would have expected, and highlights being caught short generation, for whatever reason, is very costly whilst wholesale electricity prices are so high. Our forecast changes reflect the lower hydro generation outlook and initial estimates of the impact of the&nbsp;Kawerau&nbsp;outage, which will hit FY22 harder. We have lowered our target price -10cps to NZ$6.00. UNDERPERFORM.</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings:</strong>&nbsp;FY21/FY22/FY23 EBITDAF reduced -12%/-10%/-1% to NZ$461m/NZ$570m/NZ$665m</li>
<li><strong>Dividend</strong>:&nbsp;FY21 unchanged at 17.0cps, FY22/FY23 -2.5cps/-1.0cps to 19.0cps/24.0cps</li>
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<h3>Downgrade surprises in magnitude, raises risk management questions</h3>
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<p>MCY's&nbsp;-NZ$60m downgrade (~-NZ$66m if associate earnings upside is ignored) surprised due to its magnitude. The downgrade is&nbsp;MCY's&nbsp;largest ever guidance change&nbsp;(positive or negative) and the implied wholesale price exposure of NZ$260/MWh&nbsp;is close to spot price levels, indicating MCY is relying on the market to provide short-term cover.&nbsp;Given the downside risk&nbsp;MCY faces if hydro conditions remain challenging, we expect it will take on more hedge cover whilst gas shortages continue to elevate wholesale electricity prices. This is&nbsp;factored in our FY22 and FY23 earnings downgrades.</p>
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<h3>Kawerau&nbsp;geothermal outage couldn't come at a worse time and will cause pain into FY22</h3>
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<p>MCY's 100MW Kawerau geothermal power station went offline on 7 June due to an unspecified mechanical failure. At this stage, MCY is unsure how long it will take to get Kawerau back online, but expects it will be "several months". Kawerau produces ~900GWh per annum, so this is a big power station to be lost to the market heading into winter. Business interruption insurance will kick in on 7 July, but there is a cap on wholesale electricity prices, meaning MCY remains partially exposed to high wholesale electricity prices. The September 2021 quarter ASX price is currently NZ$275/MWh. At those prices, we estimate MCY's earnings downside is ~NZ$10m/month Kawerau remains offline (net of insurance proceeds). We assume Kawerau is repaired by the end of 1Q22.</p>
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<h3>Financial impact estimated at -6cps, but sentiment impact is much greater</h3>
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<p>We have cut our FY21 and FY22 EBITDAF forecasts materially (-12% &amp; -10% respectively) which is a function of lower hydro and geothermal generation expectations. FY22 is a fluid situation, however. Whilst our revised FY22 forecast is -NZ$61m lower, it could be materially better or worse depending on rain levels and when Kawerau returns to service. The DCF impact of our forecast changes is -6cps. We have trimmed our FY22 and FY23 dividend forecasts to account for lower earnings and the downgrade is an eye-opener for the market in terms of the level of risk MCY has taken on. Our target price is -10cps lower at NZ$6.00/share.</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>Mark Robertson</strong></div>
<div><a href="mailto:mark.robertson@forsythbarr.co.nz" target="_blank" rel="noopener">mark.robertson@forsythbarr.co.<wbr>nz</a></div>
<div>+6444955264</div>
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Mercury It Hurts Being Caught Short

UNDERPERFORM
Mercury (MCY) has downgraded FY21 guidance -NZ$60m to NZ$460m, which is greater than we would have expected, and highlights being caught short generation, for whatever reason, is very costly whilst wholesale electricity prices are so high. Our forecast changes reflect the lower hydro generation outlook and initial estimates of the impact of the&nbsp;Kawerau&nbsp;outage, which will hit FY22 harder. We have lowered our target price -10cps to NZ$6.00. UNDERPERFORM.


What's changed?&nbsp;



Earnings:&nbsp;FY21/FY22/FY23 EBITDAF reduced -12%/-10%/-1% to NZ$461m/NZ$570m/NZ$665m
Dividend:&nbsp;FY21 unchanged at 17.0cps, FY22/FY23 -2.5cps/-1.0cps to 19.0cps/24.0cps



Downgrade surprises in magnitude, raises risk management questions


MCY's&nbsp;-NZ$60m downgrade (~-NZ$66m if associate earnings upside is ignored) surprised due to its magnitude. The downgrade is&nbsp;MCY's&nbsp;largest ever guidance change&nbsp;(positive or negative) and the implied wholesale price exposure of NZ$260/MWh&nbsp;is close to spot price levels, indicating MCY is relying on the market to provide short-term cover.&nbsp;Given the downside risk&nbsp;MCY faces if hydro conditions remain challenging, we expect it will take on more hedge cover whilst gas shortages continue to elevate wholesale electricity prices. This is&nbsp;factored in our FY22 and FY23 earnings downgrades.


Kawerau&nbsp;geothermal outage couldn't come at a worse time and will cause pain into FY22


MCY's 100MW Kawerau geothermal power station went offline on 7 June due to an unspecified mechanical failure. At this stage, MCY is unsure how long it will take to get Kawerau back online, but expects it will be "several months". Kawerau produces ~900GWh per annum, so this is a big power station to be lost to the market heading into winter. Business interruption insurance will kick in on 7 July, but there is a cap on wholesale electricity prices, meaning MCY remains partially exposed to high wholesale electricity prices. The September 2021 quarter ASX price is currently NZ$275/MWh. At those prices, we estimate MCY's earnings downside is ~NZ$10m/month Kawerau remains offline (net of insurance proceeds). We assume Kawerau is repaired by the end of 1Q22.


Financial impact estimated at -6cps, but sentiment impact is much greater


We have cut our FY21 and FY22 EBITDAF forecasts materially (-12% &amp; -10% respectively) which is a function of lower hydro and geothermal generation expectations. FY22 is a fluid situation, however. Whilst our revised FY22 forecast is -NZ$61m lower, it could be materially better or worse depending on rain levels and when Kawerau returns to service. The DCF impact of our forecast changes is -6cps. We have trimmed our FY22 and FY23 dividend forecasts to account for lower earnings and the downgrade is an eye-opener for the market in terms of the level of risk MCY has taken on. Our target price is -10cps lower at NZ$6.00/share.



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





Mark Robertson
mark.robertson@forsythbarr.co.nz
+6444955264



Mercury NZ Ltd

Mercury: It Hurts Being Caught Short