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</h2>
Upgrading Early in FY20 — 1Q20 Operating Statistics
Mercury (MCY) has had a strong 1Q20 and the outlook is positive for the remainder of FY20, such that it has lifted FY20 EBITDAF guidance +$25m to $510m. We have lifted our FY20 EBITDAF forecast +$26m to $514m, with the main drivers of the upgrade being strong wholesale electricity prices and a return to above average hydrology (albeit only slightly).
What’s changed?
<ul>
<li>Earnings: FY20 EBITDAF increased +$26m (+5.3%) to $514m</li>
<li>Target Price: Increased +10cps (+2.2%)</li>
<li>Rating: UNDERPERFORM rating retained</li>
</ul>
Powering ahead into FY20
Three factors stood out in 1Q20, enabling MCY to lift its FY20 EBITDAF guidance +$25m. First, hydro generation was above average for the first time since 1Q19, and current lake levels are also above average for the first time in a year. This has enabled MCY to lift its FY20 hydro generation guidance to +50GWh above normal. Second, high ASX future prices are remaining high and that is now flowing through into MCY’s reported commercial and industrial prices, which were up +6.7% in 1Q20 vs. pcp (compared with less than +2% in previous quarters). Third, MCY has dropped a significant number of dairy connections (total electricity connection numbers fell -12,000 in 1Q20, the biggest ever quarterly decline). With wholesale electricity prices averaging over $115/MWh in 1Q20, and expected to stay higher for longer, this provides MCY with extra margin (i.e. generation volumes that were previously sold to the dairy sector can now be sold on the spot electricity market at a higher margin).
Forecast changes limited to FY20 and FY21
We have increased our FY20 EBITDAF forecast +$26m to $514m and our FY21 EBITDAF forecast +$6m to $528m. The assumed wholesale electricity price increase is more material in FY20 (up +12%) and is only up +3% in FY21 and less than +1% in FY22. In our view wholesale electricity prices are unsustainably high, above $100/MWh, given the cost of building new generation (after adjusting for wind discount factors) is below $80/MWh. We, therefore, expect wholesale prices to fall in due course, although that may be a couple of years away. This is also the reason why our FY22 EBITDAF forecast is effectively unchanged.
The +10cps increase in our target price to $4.55 reflects the near-term earnings increases and a recent increase in our Tilt Renewables (TLT) valuation.
MSCI Index inclusion looking likely
Our analysis indicates that on Friday 8 November, it will be announced that MCY will enter the MSCI New Zealand Standard Index.&nbsp;
<div class="content-highlight">
Investment View
Our rating is UNDERPERFORM. MCY is a quality company with some near-term earnings growth from its wind farm development and more favourable wholesale electricity market conditions. However, in our view MCY is now expensive and the expected returns do not justify the risk.
</div>
<a target="_blank"></a><a target="_blank">Andrew Harvey-Green</a>
<a target="_blank">andrew.harvey-green@forsythbarr.co.nz</a>
<a target="_blank">+64 4 495 8185</a>

Mercury
Upgrading Early in FY20 — 1Q20 Operating Statistics
Mercury (MCY) has had a strong 1Q20 and the outlook is positive for the remainder of FY20, such that it has lifted FY20 EBITDAF guidance +$25m to $510m. We have lifted our FY20 EBITDAF forecast +$26m to $514m, with the main drivers of the upgrade being strong wholesale electricity prices and a return to above average hydrology (albeit only slightly).
What’s changed?

Earnings: FY20 EBITDAF increased +$26m (+5.3%) to $514m
Target Price: Increased +10cps (+2.2%)
Rating: UNDERPERFORM rating retained

Powering ahead into FY20
Three factors stood out in 1Q20, enabling MCY to lift its FY20 EBITDAF guidance +$25m. First, hydro generation was above average for the first time since 1Q19, and current lake levels are also above average for the first time in a year. This has enabled MCY to lift its FY20 hydro generation guidance to +50GWh above normal. Second, high ASX future prices are remaining high and that is now flowing through into MCY’s reported commercial and industrial prices, which were up +6.7% in 1Q20 vs. pcp (compared with less than +2% in previous quarters). Third, MCY has dropped a significant number of dairy connections (total electricity connection numbers fell -12,000 in 1Q20, the biggest ever quarterly decline). With wholesale electricity prices averaging over $115/MWh in 1Q20, and expected to stay higher for longer, this provides MCY with extra margin (i.e. generation volumes that were previously sold to the dairy sector can now be sold on the spot electricity market at a higher margin).
Forecast changes limited to FY20 and FY21
We have increased our FY20 EBITDAF forecast +$26m to $514m and our FY21 EBITDAF forecast +$6m to $528m. The assumed wholesale electricity price increase is more material in FY20 (up +12%) and is only up +3% in FY21 and less than +1% in FY22. In our view wholesale electricity prices are unsustainably high, above $100/MWh, given the cost of building new generation (after adjusting for wind discount factors) is below $80/MWh. We, therefore, expect wholesale prices to fall in due course, although that may be a couple of years away. This is also the reason why our FY22 EBITDAF forecast is effectively unchanged.
The +10cps increase in our target price to $4.55 reflects the near-term earnings increases and a recent increase in our Tilt Renewables (TLT) valuation.
MSCI Index inclusion looking likely
Our analysis indicates that on Friday 8 November, it will be announced that MCY will enter the MSCI New Zealand Standard Index.&nbsp;

Investment View
Our rating is UNDERPERFORM. MCY is a quality company with some near-term earnings growth from its wind farm development and more favourable wholesale electricity market conditions. However, in our view MCY is now expensive and the expected returns do not justify the risk.

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

Mercury: Upgrading Early in FY20 — 1Q20 Operating Statistics

Mercury NZ Ltd

Mercury: Upgrading Early in FY20 — 1Q20 Operating Statistics