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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Meridian Energy<br>Australia Sale Likely to Yield Special Dividend</h2>
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<p><strong>UNDERPERFORM</strong></p>
<p>Meridian Energy's (MEL) Australian business sale process is nearing a conclusion with a sizeable special dividend a probable outcome for shareholders, although the quantum depends on the final sale price. Assuming MEL sells its Australian business, we estimate a special dividend of be between NZ10cps and NZ20cps (with our spot estimate NZ15cps) and that MEL will halt its dividend reinvestment plan. Whilst our assumed NZ$820m sale price lifts our valuation +11cps, we continue to see downside risk as the MEL gross dividend yield remains on a narrow spread vs. the 10-yr swap rate. We have trimmed our target price -15cps (-3.2%) to NZ$4.60 and retain our UNDERPERFORM rating.</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings</strong>:&nbsp;We have removed the Australian business from&nbsp;MEL's&nbsp;earnings, with an assumed transaction date of 31 March 2022</li>
<li><strong>Target price</strong>:&nbsp;Decreased -NZ15cps (-3.2%) to NZ$4.60</li>
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<h3>Australian strategic review nearing a conclusion, sale appears most likely outcome</h3>
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<p>MEL's&nbsp;strategic review of its Australian business is nearing a conclusion, with final bids due and MEL expected to report the review outcome before month end. If Australian media reports are correct, three&nbsp;motivated bidders are seeking to buy&nbsp;MEL's&nbsp;Australian business. Whilst it is possible MEL decides not to sell, it&nbsp;appears&nbsp;unlikely. We have previously estimated a sale price of between NZ$670m&nbsp;and NZ$970m, with rising interest rates making the top of the range more challenging to achieve. We assume a sale price of NZ$820m (middle of the range), which in our view would be a good outcome for MEL.</p>
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<h3>What will MEL do with the cash and its dividend reinvestment plan (DRP)?</h3>
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<p>Assuming MEL sells and that it wants to avoid a credit rating upgrade, we estimate a maximum of ~NZ$400m of the proceeds can go towards the balance sheet. Above that and the net debt/EBITDAF ratio falls materially below 2.0x, risking a rating upgrade. If surplus proceeds are returned to shareholders, as we expect, that implies a special dividend of NZ10cps to NZ20cps. We assume MEL pays an NZ15cps special dividend in 2H22 (although it could be drip fed over several periods). ​​​​​​​MEL's DRP might be short-lived as arguably it is not necessary if the Australian business is sold. In addition, stopping the DRP makes growing the ordinary dividend easier as the dilutionary effect of the DRP no longer has to be overcome. We assume MEL ceases the DRP after the 1H22 interim dividend.</p>
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<h3>Modest value uplift from assumed sale but offset by on going interest rate pressures</h3>
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<p>Our DCF value of the Australian business on an operating basis is ~NZ$520m (~NZ20cps) meaning the valuation upside from a sale is between +NZ6cps and +NZ17cps. Whilst&nbsp;the sale should be a modest positive, interest rates continue to be a strong headwind and&nbsp;MEL's&nbsp;gross dividend yield remains low vs. the 10-year swap rate. We continue to see downside risk to the share price.</p>
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Meridian Energy Australia Sale Likely to Yield Special Dividend

UNDERPERFORM
Meridian Energy's (MEL) Australian business sale process is nearing a conclusion with a sizeable special dividend a probable outcome for shareholders, although the quantum depends on the final sale price. Assuming MEL sells its Australian business, we estimate a special dividend of be between NZ10cps and NZ20cps (with our spot estimate NZ15cps) and that MEL will halt its dividend reinvestment plan. Whilst our assumed NZ$820m sale price lifts our valuation +11cps, we continue to see downside risk as the MEL gross dividend yield remains on a narrow spread vs. the 10-yr swap rate. We have trimmed our target price -15cps (-3.2%) to NZ$4.60 and retain our UNDERPERFORM rating.


What's changed?&nbsp;



Earnings:&nbsp;We have removed the Australian business from&nbsp;MEL's&nbsp;earnings, with an assumed transaction date of 31 March 2022
Target price:&nbsp;Decreased -NZ15cps (-3.2%) to NZ$4.60



Australian strategic review nearing a conclusion, sale appears most likely outcome


MEL's&nbsp;strategic review of its Australian business is nearing a conclusion, with final bids due and MEL expected to report the review outcome before month end. If Australian media reports are correct, three&nbsp;motivated bidders are seeking to buy&nbsp;MEL's&nbsp;Australian business. Whilst it is possible MEL decides not to sell, it&nbsp;appears&nbsp;unlikely. We have previously estimated a sale price of between NZ$670m&nbsp;and NZ$970m, with rising interest rates making the top of the range more challenging to achieve. We assume a sale price of NZ$820m (middle of the range), which in our view would be a good outcome for MEL.


What will MEL do with the cash and its dividend reinvestment plan (DRP)?


Assuming MEL sells and that it wants to avoid a credit rating upgrade, we estimate a maximum of ~NZ$400m of the proceeds can go towards the balance sheet. Above that and the net debt/EBITDAF ratio falls materially below 2.0x, risking a rating upgrade. If surplus proceeds are returned to shareholders, as we expect, that implies a special dividend of NZ10cps to NZ20cps. We assume MEL pays an NZ15cps special dividend in 2H22 (although it could be drip fed over several periods). ​​​​​​​MEL's DRP might be short-lived as arguably it is not necessary if the Australian business is sold. In addition, stopping the DRP makes growing the ordinary dividend easier as the dilutionary effect of the DRP no longer has to be overcome. We assume MEL ceases the DRP after the 1H22 interim dividend.


Modest value uplift from assumed sale but offset by on going interest rate pressures


Our DCF value of the Australian business on an operating basis is ~NZ$520m (~NZ20cps) meaning the valuation upside from a sale is between +NZ6cps and +NZ17cps. Whilst&nbsp;the sale should be a modest positive, interest rates continue to be a strong headwind and&nbsp;MEL's&nbsp;gross dividend yield remains low vs. the 10-year swap rate. We continue to see downside risk to the share price.


Meridian Energy: Australia Sale Likely to Yield Special Dividend