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>
Winding Up Turitea Stage 2
Mercury’s (MCY) biennial investor day was overshadowed by the news that MCY has committed to building stage two of its Turitea wind farm. Whilst the decision is interesting in light of NZAS’s strategic review creating market uncertainty, our analysis indicates the project should be value positive with a wholesale electricity price above $60/MWh, hence, there is good downside protection if NZAS were to close.
What’s changed?
<ul>
<li>Earnings: FY20E unchanged, FY21E/FY22E EBITDAF up +$2m/+$11m</li>
<li>Target Price: Increased +9cps to $4.62 mainly due to Turitea South</li>
<li>Rating: NEUTRAL rating retained</li>
</ul>
Turitea South value positive
MCY has pushed go on Stage 2 of its Turitea wind farm, adding a further 103MW/370GWh pa to the Turitea North wind farm. The announcement was a slight surprise given the NZAS strategic review has created electricity demand (and therefore electricity price) uncertainty. However, the economics stack up, even if NZAS were to close. Add in the fact that the resource consents were due to expire in 2021 and the announcement will make other generators think twice about building their own projects, and the decision is understandable. We estimate that the Turitea South ungeared IRR is above 10% and will add ~+5cps. MCY has indicated at an ~$80MWh price Turitea South will add EBITDAF of ~$25m (albeit not until FY23), in addition to the ~$30m from Turitea North.
Dividend path flattened in FY22, increased in FY23 and beyond
We have lowered our FY22 dividend forecast -3.3cps to 18.6cps as we now assume a lower payout ratio until the wind farm is commissioned and there is a full year of earnings in FY23. This is still +2.4cps up on our FY21 forecast and reflects earnings from Turitea Stage 1. However, the FY23 dividend assumption is now +1.5cps higher at 23.1cps (a cash yield of 4.6%).
C&amp;I book roll-off guidance confirms solid earnings growth
MCY has solid earnings growth in the next two financial years, before Turitea wind farm earnings kick in from FY22 onwards. At the end of FY19 MCY’s commercial and industrial sales yet to be contracted at the current wholesale electricity prices totalled ~2,000GWh. With the long-dated futures prices ~+$20/MWh higher than 12-months ago, MCY’s commercial sales will add ~+$40m to EBITDAF over the next four/five years it will take to re-contract (assuming wholesale prices hold). We currently assume wholesale electricity prices decline from current elevated levels, so the upside is not quite +$40m. MCY also indicated it is seeking ~+$20m EBITDAF growth from general operational improvements by FY22. Whilst we have lifted our FY22 EBITDAF forecast +$11m to $557m (~70% of which is due to Turitea South commissioning volumes), we have not explicitly included these operational improvements.
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Investment View
Our rating is NEUTRAL. MCY is a quality operator in a sector with a positive long-term outlook. Whilst MCY demonstrated at its investor day that it has a solid near-term earnings growth profile, we believe that is largely factored into the current share price.
</div>
Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185

Mercury
Winding Up Turitea Stage 2
Mercury’s (MCY) biennial investor day was overshadowed by the news that MCY has committed to building stage two of its Turitea wind farm. Whilst the decision is interesting in light of NZAS’s strategic review creating market uncertainty, our analysis indicates the project should be value positive with a wholesale electricity price above $60/MWh, hence, there is good downside protection if NZAS were to close.
What’s changed?

Earnings: FY20E unchanged, FY21E/FY22E EBITDAF up +$2m/+$11m
Target Price: Increased +9cps to $4.62 mainly due to Turitea South
Rating: NEUTRAL rating retained

Turitea South value positive
MCY has pushed go on Stage 2 of its Turitea wind farm, adding a further 103MW/370GWh pa to the Turitea North wind farm. The announcement was a slight surprise given the NZAS strategic review has created electricity demand (and therefore electricity price) uncertainty. However, the economics stack up, even if NZAS were to close. Add in the fact that the resource consents were due to expire in 2021 and the announcement will make other generators think twice about building their own projects, and the decision is understandable. We estimate that the Turitea South ungeared IRR is above 10% and will add ~+5cps. MCY has indicated at an ~$80MWh price Turitea South will add EBITDAF of ~$25m (albeit not until FY23), in addition to the ~$30m from Turitea North.
Dividend path flattened in FY22, increased in FY23 and beyond
We have lowered our FY22 dividend forecast -3.3cps to 18.6cps as we now assume a lower payout ratio until the wind farm is commissioned and there is a full year of earnings in FY23. This is still +2.4cps up on our FY21 forecast and reflects earnings from Turitea Stage 1. However, the FY23 dividend assumption is now +1.5cps higher at 23.1cps (a cash yield of 4.6%).
C&amp;I book roll-off guidance confirms solid earnings growth
MCY has solid earnings growth in the next two financial years, before Turitea wind farm earnings kick in from FY22 onwards. At the end of FY19 MCY’s commercial and industrial sales yet to be contracted at the current wholesale electricity prices totalled ~2,000GWh. With the long-dated futures prices ~+$20/MWh higher than 12-months ago, MCY’s commercial sales will add ~+$40m to EBITDAF over the next four/five years it will take to re-contract (assuming wholesale prices hold). We currently assume wholesale electricity prices decline from current elevated levels, so the upside is not quite +$40m. MCY also indicated it is seeking ~+$20m EBITDAF growth from general operational improvements by FY22. Whilst we have lifted our FY22 EBITDAF forecast +$11m to $557m (~70% of which is due to Turitea South commissioning volumes), we have not explicitly included these operational improvements.

Investment View
Our rating is NEUTRAL. MCY is a quality operator in a sector with a positive long-term outlook. Whilst MCY demonstrated at its investor day that it has a solid near-term earnings growth profile, we believe that is largely factored into the current share price.

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

Mercury NZ Ltd

Mercury: Winding Up Turitea Stage 2