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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>Conservative and Bullish Dividend — 1H22</h2>
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<p><strong>UNDERPERFORM</strong></p>
<p>Meridian Energy's (MEL) 1H22 result was solid with EBITDAF (inclusive of Australia) coming in at NZ$418m, -NZ$4m down on 1H21 with strong hydro generation offsetting the impact of the lower NZAS contract price. MEL's revised dividend policy appears to have disappointed the market, with no sign of the special dividend we had anticipated. Whilst the interim ordinary dividend increased +0.15cps to 7.85cps, our FY22 dividend forecast is -2.0cps (-11%) lower due to the lack of a special dividend. Outside the dividend our near-term forecasts are effectively unchanged but firming long-dated ASX prices helps boosts long-term earnings and offsets much of our cost of capital increase. Our target price remains unchanged at NZ$4.40 and our rating is UNDERPERFORM with MEL's current gross yield modestly above bond rates.</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings</strong>: FY22/FY23/FY24 EBITDAF changed -1.2%/+0.2%/0.2% to NZ$735m/NZ$701m/NZ$756m</li>
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<h3>High hydro offsets lower NZAS contract price</h3>
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<p>MEL's&nbsp;flat 1H22 result (at both EBITDAF and normalised NPAT) vs. 1H21 came courtesy of 1H22 hydro generation +8% more than 1H21, offsetting the -NZ$58m hit to earnings from the lower NZAS contract price.&nbsp;MEL's&nbsp;continued retail growth lifted sales +8%. Whilst MEL is taking a long-term approach to its mass market retail strategy, in the short-to-medium term it is giving up potentially higher priced channels.&nbsp;</p>
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<h3>Dividend decision conservative on one hand, bullish on the other</h3>
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<p>A key focus of the result was MEL's capital management intentions following the sale of its Australian business. MEL decided against the expected special dividend approach, instead lifting the free cash flow payout ratio range to 80% to 100% (up from 75% to 90%). It has also maintained its DRP, despite now having surplus capital, but has removed the discount. MEL's interim 7.85cps dividend represents a rolling 12-month payout ratio of 93%. Whilst no special dividend is conservative, the high payout ratio following an above average hydro generation period is not, and our FY23 EBITDAF forecast is below FY22 following the sale of Australia. MEL could easily test the top of its payout ratio range in FY22 and FY23 ahead of Harapaki wind revenue, lifting FY24 earnings.</p>
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<h3>Minor near-term outlook changes, longer-term looks more attractive but NZAS + hydrogen may not be a good outcome</h3>
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<p>The only adjustment of note to our FY22 forecast is the removal of two months of Australian EBITDAF. However, 2024 and 2025 ASX futures prices have strengthened materially, moderately lifting the long-term outlook to offset our higher risk free rate assumption.&nbsp;MEL's&nbsp;commentary on hydrogen remains bullish, such that it sees the potential to supply both NZAS and hydrogen. Given hydrogen needs a low electricity price to be economic&nbsp;we would be cautious on whether that is a good outcome for investors.</p>
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Meridian Energy Conservative and Bullish Dividend — 1H22

UNDERPERFORM
Meridian Energy's (MEL) 1H22 result was solid with EBITDAF (inclusive of Australia) coming in at NZ$418m, -NZ$4m down on 1H21 with strong hydro generation offsetting the impact of the lower NZAS contract price. MEL's revised dividend policy appears to have disappointed the market, with no sign of the special dividend we had anticipated. Whilst the interim ordinary dividend increased +0.15cps to 7.85cps, our FY22 dividend forecast is -2.0cps (-11%) lower due to the lack of a special dividend. Outside the dividend our near-term forecasts are effectively unchanged but firming long-dated ASX prices helps boosts long-term earnings and offsets much of our cost of capital increase. Our target price remains unchanged at NZ$4.40 and our rating is UNDERPERFORM with MEL's current gross yield modestly above bond rates.


What's changed?&nbsp;



Earnings: FY22/FY23/FY24 EBITDAF changed -1.2%/+0.2%/0.2% to NZ$735m/NZ$701m/NZ$756m



High hydro offsets lower NZAS contract price


MEL's&nbsp;flat 1H22 result (at both EBITDAF and normalised NPAT) vs. 1H21 came courtesy of 1H22 hydro generation +8% more than 1H21, offsetting the -NZ$58m hit to earnings from the lower NZAS contract price.&nbsp;MEL's&nbsp;continued retail growth lifted sales +8%. Whilst MEL is taking a long-term approach to its mass market retail strategy, in the short-to-medium term it is giving up potentially higher priced channels.&nbsp;


Dividend decision conservative on one hand, bullish on the other


A key focus of the result was MEL's capital management intentions following the sale of its Australian business. MEL decided against the expected special dividend approach, instead lifting the free cash flow payout ratio range to 80% to 100% (up from 75% to 90%). It has also maintained its DRP, despite now having surplus capital, but has removed the discount. MEL's interim 7.85cps dividend represents a rolling 12-month payout ratio of 93%. Whilst no special dividend is conservative, the high payout ratio following an above average hydro generation period is not, and our FY23 EBITDAF forecast is below FY22 following the sale of Australia. MEL could easily test the top of its payout ratio range in FY22 and FY23 ahead of Harapaki wind revenue, lifting FY24 earnings.


Minor near-term outlook changes, longer-term looks more attractive but NZAS + hydrogen may not be a good outcome


The only adjustment of note to our FY22 forecast is the removal of two months of Australian EBITDAF. However, 2024 and 2025 ASX futures prices have strengthened materially, moderately lifting the long-term outlook to offset our higher risk free rate assumption.&nbsp;MEL's&nbsp;commentary on hydrogen remains bullish, such that it sees the potential to supply both NZAS and hydrogen. Given hydrogen needs a low electricity price to be economic&nbsp;we would be cautious on whether that is a good outcome for investors.


Meridian Energy: Conservative and Bullish Dividend — 1H22