New Zealand Professional Investment Services Firm

Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Meridian Energy<br>Gravity Defying Hydro</h2>
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<p><strong>UNDERPERFORM</strong></p>
<p>We are downgrading our Meridian Energy (MEL) rating to UNDERPERFORM from NEUTRAL following its recent share price surge and increase in interest rates (which should be a negative for yield stocks). MEL is now trading on a record low cash dividend yield of 2.8% (gross dividend yield of 3.6%) and the spread between MEL's gross dividend yield and the 10-year swap rate is below 3.0% for the first time. Other yield and electricity investments offer better value, in our view.&nbsp;</p>
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<h3>What's changed?&nbsp;</h3>
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<li><strong>Earnings</strong>:&nbsp;FY21 EBITDAF increased +NZ$17m (+2.3%) to NZ$765m</li>
<li><strong>Target price</strong>:&nbsp;Increased +6cps (+1.1%) to NZ$5.50</li>
<li><strong>Rating:</strong>&nbsp;Downgraded to UNDERPERFORM from NEUTRAL</li>
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<h3>Dividend yield relative to interest rates sinks to new low</h3>
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<p>As a result of market movements the spread between MEL's gross dividend yield and the 10-year swap rate has collapsed to a record low 2.8%. On no news flow, MEL's share price has surged +23% since the end of September 2020 to record highs over NZ$6.00. Over the same period, the 10-year swap rate has also increased +36 basis points to 0.86%, the highest since early June 2020. With dividend growth likely to be muted in the next few years (at best) MEL is an expensive defensive, in our view.</p>
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<h3>High share price creates asymmetric downside risk to NZAS closing</h3>
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<p>The market appears to be assuming that NZAS will remain open. Whilst that appears the most likely scenario, it is not a fait accompli. The share price run has been such that there is now asymmetric risk to the downside, with limited/no share price upside if Rio Tinto decides to keep NZAS open for longer. Our current FY21 dividend forecast of 16.9cps is unlikely to change if NZAS remains open beyond August 2021 for two reasons. First, if NZAS remains open, we estimate that average hydro EBITDAF will be between NZ$700m to NZ$720m, supporting a dividend of 16.5cps to 16.9cps at the top end of MEL's dividend pay out policy range. Second, if NZAS remains open MEL is likely to build its Hawkes Bay wind farm development option and will need capital for that purpose. We do not expect MEL to reinstate its capital management program (i.e. the 4.88cps special dividend).</p>
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<h3>Strong October operating performance as hydro generation volumes return</h3>
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<p>We estimate MEL's October 2020 EBITDAF was NZ$76m, up +NZ$7m on the prior year. A new record NZ Energy Margin (NZ$97m, up +NZ$4m driven by a strong retail performance and above average hydro generation volumes) and lower transmission charges are the main factors behind the strong October operating performance. We have lifted our FY21 EBITDAF forecast +NZ$17m (+2.3%) to $765m with retail prices and higher value sales volumes tracking ahead of our old forecast. A recovery in hydro storage has also helped. The increase in our near-term earnings forecast has lifted our target price +6cps to NZ$5.50.</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>Scott Anderson</strong></div>
<div><a href="mailto:scott.anderson@forsythbarr.co.nz" target="_blank" rel="noopener">scott.anderson@forsythbarr.co.<wbr>nz</a></div>
<div>+64 4 914 2219</div>
</div>
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Meridian Energy Gravity Defying Hydro

UNDERPERFORM
We are downgrading our Meridian Energy (MEL) rating to UNDERPERFORM from NEUTRAL following its recent share price surge and increase in interest rates (which should be a negative for yield stocks). MEL is now trading on a record low cash dividend yield of 2.8% (gross dividend yield of 3.6%) and the spread between MEL's gross dividend yield and the 10-year swap rate is below 3.0% for the first time. Other yield and electricity investments offer better value, in our view.&nbsp;


What's changed?&nbsp;



Earnings:&nbsp;FY21 EBITDAF increased +NZ$17m (+2.3%) to NZ$765m
Target price:&nbsp;Increased +6cps (+1.1%) to NZ$5.50
Rating:&nbsp;Downgraded to UNDERPERFORM from NEUTRAL



Dividend yield relative to interest rates sinks to new low


As a result of market movements the spread between MEL's gross dividend yield and the 10-year swap rate has collapsed to a record low 2.8%. On no news flow, MEL's share price has surged +23% since the end of September 2020 to record highs over NZ$6.00. Over the same period, the 10-year swap rate has also increased +36 basis points to 0.86%, the highest since early June 2020. With dividend growth likely to be muted in the next few years (at best) MEL is an expensive defensive, in our view.


High share price creates asymmetric downside risk to NZAS closing


The market appears to be assuming that NZAS will remain open. Whilst that appears the most likely scenario, it is not a fait accompli. The share price run has been such that there is now asymmetric risk to the downside, with limited/no share price upside if Rio Tinto decides to keep NZAS open for longer. Our current FY21 dividend forecast of 16.9cps is unlikely to change if NZAS remains open beyond August 2021 for two reasons. First, if NZAS remains open, we estimate that average hydro EBITDAF will be between NZ$700m to NZ$720m, supporting a dividend of 16.5cps to 16.9cps at the top end of MEL's dividend pay out policy range. Second, if NZAS remains open MEL is likely to build its Hawkes Bay wind farm development option and will need capital for that purpose. We do not expect MEL to reinstate its capital management program (i.e. the 4.88cps special dividend).


Strong October operating performance as hydro generation volumes return


We estimate MEL's October 2020 EBITDAF was NZ$76m, up +NZ$7m on the prior year. A new record NZ Energy Margin (NZ$97m, up +NZ$4m driven by a strong retail performance and above average hydro generation volumes) and lower transmission charges are the main factors behind the strong October operating performance. We have lifted our FY21 EBITDAF forecast +NZ$17m (+2.3%) to $765m with retail prices and higher value sales volumes tracking ahead of our old forecast. A recovery in hydro storage has also helped. The increase in our near-term earnings forecast has lifted our target price +6cps to NZ$5.50.



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





Scott Anderson
scott.anderson@forsythbarr.co.nz
+64 4 914 2219



Meridian Energy

Meridian Energy: Gravity Defying Hydro