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Forsyth Barr

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New Zealand Professional Investment Services Firm, Forsyth Barr

Equity Bottom-Up

<h2>Meridian Energy</h2>

Peak Earnings — FY19 Result
Meridian Energy’s (MEL) FY19 result was sensational, producing EBITDAF of $838m, +$172m (+26%) higher than the pcp. Driving the record result were high hydro generation volumes and record wholesale electricity prices. The result was anticipated, hence, forecast changes are relatively small, although we have increased our target price +20cps to $4.00.
What’s changed?
<ul>
<li>Earnings: FY20 EBITDAF increased +$4m to $769m</li>
<li>Target Price: Lifted +20cps to $4.00</li>
<li>Rating:&nbsp;UNDERPERFORM rating retained</li>
</ul>
FY19 likely to be peak earnings
It is unusual for MEL to have both strong hydro generation volumes (~+5% above average) and high wholesale prices (+47% above pcp). But that is what occurred in FY19, with wholesale electricity prices elevated due to gas shortage issues, as opposed to low hydrology as is normally the case. It is little wonder that MEL’s presentation cover page was a picture of a mountain top! In addition to favourable wholesale market conditions, FY19 was the first full year of Green State Power (GSP) earnings (~+$20m), the Australian hedging position improved materially (+$14m) and MEL was able to secure good commercial sales volumes at strong prices (+$29m). Normalised NPAT of $333m was +62% better than the pcp.
Dividend approach demonstrates confidence
MEL declared a final ordinary dividend of 10.72cps, in addition to the standard “special” dividend of 2.44cps. We had assumed MEL would increase its special dividend, allowing shareholders to benefit from the strong FY19 result, but also recognising FY19 is unlikely to be repeated soon. By rigidly sticking to the free cash flow (FCF) pay-out policy (the ordinary dividend is based on a minimum pay-out ratio of 75%), MEL has demonstrated confidence in FY20 earnings as a weak result would either require MEL to exceed its upper FCF pay-out bound of 90%, or cut the ordinary dividend. Given MEL’s dividend approach, we have lifted our FY20 total dividend forecast +0.6cps to 21.4cps (just +0.1cps up on FY19). However, we still expect a small decline in the total FY22 dividend after the special dividend program ends in 1H22.
Minor forecast changes, with the exception of depreciation
We have increased our FY20 EBITDAF forecast +$4m to $769m. However, the biggest change is a +$36m increase in depreciation following MEL’s material $1.14b upwards asset revaluation (due to lower interest rates). Whilst our headline NPAT forecast falls -8.0% to $259m, NPAT adjusted for maintenance capex has lifted +1.5% to $442m.
Target price increase, due mainly to WACC changes
We have increased our target price +20cps (+5.3%) to $4.00 with the main driver being a +16% increase in our DCF valuation due to a lower risk free rate assumption. However, we still view MEL as an expensive electricity generator/retailer and we retain our UNDERPERFORM rating.&nbsp;
<div class="content-highlight">
Investment View
Our rating is UNDERPERFORM. Whilst MEL is a high quality stock, in our view it offers less value than alternative electricity generator/retailers. Short-term trading conditions have been strong highlighted by the FY19 result, albeit we do not expect a repeat of that performance.
</div>
Andrew Harvey-Green
andrew.harvey-green@forsythbarr.co.nz
+64 4 495 8185

Meridian Energy

Peak Earnings — FY19 Result
Meridian Energy’s (MEL) FY19 result was sensational, producing EBITDAF of $838m, +$172m (+26%) higher than the pcp. Driving the record result were high hydro generation volumes and record wholesale electricity prices. The result was anticipated, hence, forecast changes are relatively small, although we have increased our target price +20cps to $4.00.
What’s changed?

Earnings: FY20 EBITDAF increased +$4m to $769m
Target Price: Lifted +20cps to $4.00
Rating:&nbsp;UNDERPERFORM rating retained

FY19 likely to be peak earnings
It is unusual for MEL to have both strong hydro generation volumes (~+5% above average) and high wholesale prices (+47% above pcp). But that is what occurred in FY19, with wholesale electricity prices elevated due to gas shortage issues, as opposed to low hydrology as is normally the case. It is little wonder that MEL’s presentation cover page was a picture of a mountain top! In addition to favourable wholesale market conditions, FY19 was the first full year of Green State Power (GSP) earnings (~+$20m), the Australian hedging position improved materially (+$14m) and MEL was able to secure good commercial sales volumes at strong prices (+$29m). Normalised NPAT of $333m was +62% better than the pcp.
Dividend approach demonstrates confidence
MEL declared a final ordinary dividend of 10.72cps, in addition to the standard “special” dividend of 2.44cps. We had assumed MEL would increase its special dividend, allowing shareholders to benefit from the strong FY19 result, but also recognising FY19 is unlikely to be repeated soon. By rigidly sticking to the free cash flow (FCF) pay-out policy (the ordinary dividend is based on a minimum pay-out ratio of 75%), MEL has demonstrated confidence in FY20 earnings as a weak result would either require MEL to exceed its upper FCF pay-out bound of 90%, or cut the ordinary dividend. Given MEL’s dividend approach, we have lifted our FY20 total dividend forecast +0.6cps to 21.4cps (just +0.1cps up on FY19). However, we still expect a small decline in the total FY22 dividend after the special dividend program ends in 1H22.
Minor forecast changes, with the exception of depreciation
We have increased our FY20 EBITDAF forecast +$4m to $769m. However, the biggest change is a +$36m increase in depreciation following MEL’s material $1.14b upwards asset revaluation (due to lower interest rates). Whilst our headline NPAT forecast falls -8.0% to $259m, NPAT adjusted for maintenance capex has lifted +1.5% to $442m.
Target price increase, due mainly to WACC changes
We have increased our target price +20cps (+5.3%) to $4.00 with the main driver being a +16% increase in our DCF valuation due to a lower risk free rate assumption. However, we still view MEL as an expensive electricity generator/retailer and we retain our UNDERPERFORM rating.&nbsp;

Investment View
Our rating is UNDERPERFORM. Whilst MEL is a high quality stock, in our view it offers less value than alternative electricity generator/retailers. Short-term trading conditions have been strong highlighted by the FY19 result, albeit we do not expect a repeat of that performance.

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

Meridian Energy: Peak Earnings — FY19 Result