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><a target="_blank">Power Point</a></h2>
November 2019 — NZAS Investor Angst
Rio Tinto’s (RIO) announcement that it is undertaking a strategic review of NZAS has caused significant angst amongst investors, such that the market cap of the sector is down -12%. Whilst we believe that NZAS is unlikely to close (less than a 10% chance), the threat of closure is once again at the forefront of investors’ minds. In our view the share price reaction has been overdone and so we have upgraded our Contact Energy (CEN) and Genesis Energy (GNE) ratings to OUTPERFORM and our Mercury (MCY) and Meridian Energy (MEL) ratings to NEUTRAL.
Sector target price and rating changes
We have lowered our target prices between -0.4% and -3.3% reflecting the downside risk associated with NZAS closing. Most of the downside is related to lower electricity wholesale prices and thus far, the futures curve has shown little negative reaction. However, investor reaction has been far greater for CEN and MEL in particular, down -15% and -12% respectively. We believe the market reaction is overdone, hence, the upgrade in our ratings. Further details of the target price changes and transmission implications can be found in our report&nbsp;Tiwai Transmission Cure to Take Time.
Electricity demand up, wholesale electricity prices remain elevated
October 2019 electricity demand was up +2.6%, with cooler weather and increased irrigation load the likely drivers. Wholesale electricity prices remain little changed, with Benmore (BEN) averaging $119/MWh (same as September) and Otahuhu (OTA) up +3% to $128/MWh. Hydro lake storage gradually improved but remains below average. However, we note that Lake Taupo storage is currently 125% of average and it is apparent that MCY is holding back water with an eye on potentially higher prices later in the financial year.
MSCI decision imminent
On Friday 8 November, the MSCI Index update will be announced. We expect MCY will enter the Index and there is an outside chance that CEN will also enter; but that requires the number of constituents to increase to eight and for MSCI to assess index membership on one of two days in the 10 day window
Figure 1. Summary company valuation metric
<table class="table table-striped"><colgroup><col> <col span="8"></colgroup>
<tbody>
<tr>
<td rowspan="2" style="text-align: center; width: 45pt;">Ticker</td>
<td style="text-align: center; width: 48pt;"></td>
<td style="text-align: center; width: 48pt;">Target</td>
<td style="text-align: center; width: 48pt;">Target</td>
<td style="text-align: center; width: 48pt;"></td>
<td colspan="3" style="text-align: center; width: 144pt;">FY20</td>
<td style="text-align: center; width: 48pt;">EBITDAF</td>
</tr>
<tr>
<td style="text-align: center;">Price</td>
<td style="text-align: center;">Price</td>
<td style="text-align: center;">Return</td>
<td style="text-align: center;">Rating</td>
<td style="text-align: center;">EV/EBITDA</td>
<td style="text-align: center;">PE</td>
<td style="text-align: center;">Gr Yld*</td>
<td style="text-align: center;">NZ$m</td>
</tr>
<tr>
<td style="text-align: center;">CEN</td>
<td style="text-align: center;">$7.33&nbsp;</td>
<td style="text-align: center;">$8.03&nbsp;</td>
<td style="text-align: center;">14.90%</td>
<td style="text-align: center;">OUTPERFORM</td>
<td style="text-align: center;">13.3</td>
<td style="text-align: center;">21.1</td>
<td style="text-align: center;">6.60%</td>
<td style="text-align: center;">466</td>
</tr>
<tr>
<td style="text-align: center;">GNE</td>
<td style="text-align: center;">$3.16&nbsp;</td>
<td style="text-align: center;">$3.23&nbsp;</td>
<td style="text-align: center;">7.90%</td>
<td style="text-align: center;">OUTPERFORM</td>
<td style="text-align: center;">14.7</td>
<td style="text-align: center;">30</td>
<td style="text-align: center;">7.40%</td>
<td style="text-align: center;">365</td>
</tr>
<tr>
<td style="text-align: center;">MCY</td>
<td style="text-align: center;">$4.79&nbsp;</td>
<td style="text-align: center;">$4.53&nbsp;</td>
<td style="text-align: center;">-2.10%</td>
<td style="text-align: center;">NEUTRAL</td>
<td style="text-align: center;">14.7</td>
<td style="text-align: center;">26.2</td>
<td style="text-align: center;">4.60%</td>
<td style="text-align: center;">516</td>
</tr>
<tr>
<td style="text-align: center;">MEL</td>
<td style="text-align: center;">$4.60&nbsp;</td>
<td style="text-align: center;">$4.11&nbsp;</td>
<td style="text-align: center;">-6.00%</td>
<td style="text-align: center;">NEUTRAL</td>
<td style="text-align: center;">16.2</td>
<td style="text-align: center;">24.7</td>
<td style="text-align: center;">5.80%</td>
<td style="text-align: center;">816</td>
</tr>
<tr>
<td style="text-align: center;">TLT</td>
<td style="text-align: center;">$2.96&nbsp;</td>
<td style="text-align: center;">$3.00&nbsp;</td>
<td style="text-align: center;">1.40%</td>
<td style="text-align: center;">OUTPERFORM</td>
<td style="text-align: center;">11.5</td>
<td style="text-align: center;">14</td>
<td style="text-align: center;">0.00%</td>
<td style="text-align: center;">156</td>
</tr>
<tr>
<td style="text-align: center;">TPW</td>
<td style="text-align: center;">$8.26&nbsp;</td>
<td style="text-align: center;">$8.20&nbsp;</td>
<td style="text-align: center;">3.40%</td>
<td style="text-align: center;">OUTPERFORM</td>
<td style="text-align: center;">15</td>
<td style="text-align: center;">24.5</td>
<td style="text-align: center;">5.60%</td>
<td style="text-align: center;">210</td>
</tr>
</tbody>
</table>
Source: Eikon, Forsyth Barr analysis *Includes any forecast special dividend
<div class="content-highlight">
Investment View
The share price reaction to the potential closure of NZAS has created buying opportunities in the electricity sector. We believe the risk of closure is low (less than 10%) and that CEN, GNE and Trustpower (TPW) all offer good value at present (OUTPERFORM). We are NEUTRAL on MCY and MEL.<a target="_blank">&nbsp;</a>
</div>
Andrew Harvey-Green
<a target="_blank">andrew.harvey-green@forsythbarr.co.nz</a>
<a target="_blank">+64 4 495 8185</a>
Scott Anderson
<a href="mailto:scott.anderson@forsythbarr.co.nz" target="_blank" rel="noopener">scott.anderson@forsythbarr.co.nz</a>
+64 4 914 2219

Power Point
November 2019 — NZAS Investor Angst
Rio Tinto’s (RIO) announcement that it is undertaking a strategic review of NZAS has caused significant angst amongst investors, such that the market cap of the sector is down -12%. Whilst we believe that NZAS is unlikely to close (less than a 10% chance), the threat of closure is once again at the forefront of investors’ minds. In our view the share price reaction has been overdone and so we have upgraded our Contact Energy (CEN) and Genesis Energy (GNE) ratings to OUTPERFORM and our Mercury (MCY) and Meridian Energy (MEL) ratings to NEUTRAL.
Sector target price and rating changes
We have lowered our target prices between -0.4% and -3.3% reflecting the downside risk associated with NZAS closing. Most of the downside is related to lower electricity wholesale prices and thus far, the futures curve has shown little negative reaction. However, investor reaction has been far greater for CEN and MEL in particular, down -15% and -12% respectively. We believe the market reaction is overdone, hence, the upgrade in our ratings. Further details of the target price changes and transmission implications can be found in our report&nbsp;Tiwai Transmission Cure to Take Time.
Electricity demand up, wholesale electricity prices remain elevated
October 2019 electricity demand was up +2.6%, with cooler weather and increased irrigation load the likely drivers. Wholesale electricity prices remain little changed, with Benmore (BEN) averaging $119/MWh (same as September) and Otahuhu (OTA) up +3% to $128/MWh. Hydro lake storage gradually improved but remains below average. However, we note that Lake Taupo storage is currently 125% of average and it is apparent that MCY is holding back water with an eye on potentially higher prices later in the financial year.
MSCI decision imminent
On Friday 8 November, the MSCI Index update will be announced. We expect MCY will enter the Index and there is an outside chance that CEN will also enter; but that requires the number of constituents to increase to eight and for MSCI to assess index membership on one of two days in the 10 day window
Figure 1. Summary company valuation metric
 


Ticker

Target
Target

FY20
EBITDAF


Price
Price
Return
Rating
EV/EBITDA
PE
Gr Yld*
NZ$m


CEN
$7.33&nbsp;
$8.03&nbsp;
14.90%
OUTPERFORM
13.3
21.1
6.60%
466


GNE
$3.16&nbsp;
$3.23&nbsp;
7.90%
OUTPERFORM
14.7
30
7.40%
365


MCY
$4.79&nbsp;
$4.53&nbsp;
-2.10%
NEUTRAL
14.7
26.2
4.60%
516


MEL
$4.60&nbsp;
$4.11&nbsp;
-6.00%
NEUTRAL
16.2
24.7
5.80%
816


TLT
$2.96&nbsp;
$3.00&nbsp;
1.40%
OUTPERFORM
11.5
14
0.00%
156


TPW
$8.26&nbsp;
$8.20&nbsp;
3.40%
OUTPERFORM
15
24.5
5.60%
210



Source: Eikon, Forsyth Barr analysis *Includes any forecast special dividend

Investment View
The share price reaction to the potential closure of NZAS has created buying opportunities in the electricity sector. We believe the risk of closure is low (less than 10%) and that CEN, GNE and Trustpower (TPW) all offer good value at present (OUTPERFORM). We are NEUTRAL on MCY and MEL.&nbsp;

Andrew Harvey-Green
andrew.harvey-green@forsythbarr.co.nz
+64 4 495 8185
Scott Anderson
scott.anderson@forsythbarr.co.nz
+64 4 914 2219

Power Point: November 2019 — NZAS Investor Angst