Final Decision for Spark Drives Increase in Fair Value Estimate; Looking Reasonable Value

Leading Independent Investment Research, Morningstar, Inc.

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Equity Bottom-Up

<p>The outlook for <a href="https://www.smartkarma.com/entities/595" target="_blank" data-smartkarma-citation="entities:595:1">Spark Infrastructure (SKI AU)</a> and peers is depressed by unrelenting regulatory attacks as the government tries to improve utility bill affordability. Utility bills have risen strongly in the past 15 years and while Spark wasn't a major beneficiary, it is certainly in the cross hairs now. We expect the Australian Energy Regulator, or AER, to pour over every myriad detail of the regulatory process to ensure the networks are paid no more than necessary. And the networks are more vulnerable than ever as they can no longer appeal AER decisions to an independent tribunal. At the same time, the Australian Taxation Office is closing in on the elusive Spark and will send the group its inaugural tax bill in 2019. With all this going on, Spark was forced to cut distributions by 8% in 2019 and we expect further downside in 2021 after core assets undergo their next regulatory resets. But it's not all bad. Spark is a solid business with reasonable financial leverage and a growing asset base. At the current price of AUD 2.20, distribution yield is high at 6.8% and while distributions will probably fall 10% or more over the medium term, this will be partly offset by an increase in franking credits. Despite being in the 3-star zone, the stock could appeal to those seeking yield.</p><hr><h2>Key Takeaways</h2><ul>
<li>Spark's distributions to investors are likely to be trimmed again in a few years because of pressure on earnings and ongoing capital expenditure requirements. We forecast DPS falls to around AUD 0.135 in 2021, representing a still respectable yield of 6.1% based on the current security price.</li>
<li>We remain comfortable with Spark's financial health, though we don't think it will be able to rely more heavily on debt to support distributions, particularly as credit metrics are likely to weaken.</li>
<li>High and rising electricity bills will keep the regulator keenly focused on minimising network profits. At present, it is attacking allowed returns and allowances to cover operating costs and tax.</li>
<li>Value has improved in the past couple of years. We now consider Spark fairly valued, offering a good yield balanced by a tough regulatory outlook. It trades at an 8% discount to our fair value estimate, and income-oriented investors could consider buying now.</li>
</ul>

The outlook for Spark Infrastructure (SKI AU) and peers is depressed by unrelenting regulatory attacks as the government tries to improve utility bill affordability. Utility bills have risen strongly in the past 15 years and while Spark wasn't a major beneficiary, it is certainly in the cross hairs now. We expect the Australian Energy Regulator, or AER, to pour over every myriad detail of the regulatory process to ensure the networks are paid no more than necessary. And the networks are more vulnerable than ever as they can no longer appeal AER decisions to an independent tribunal. At the same time, the Australian Taxation Office is closing in on the elusive Spark and will send the group its inaugural tax bill in 2019. With all this going on, Spark was forced to cut distributions by 8% in 2019 and we expect further downside in 2021 after core assets undergo their next regulatory resets. But it's not all bad. Spark is a solid business with reasonable financial leverage and a growing asset base. At the current price of AUD 2.20, distribution yield is high at 6.8% and while distributions will probably fall 10% or more over the medium term, this will be partly offset by an increase in franking credits. Despite being in the 3-star zone, the stock could appeal to those seeking yield.Key Takeaways
Spark's distributions to investors are likely to be trimmed again in a few years because of pressure on earnings and ongoing capital expenditure requirements. We forecast DPS falls to around AUD 0.135 in 2021, representing a still respectable yield of 6.1% based on the current security price.
We remain comfortable with Spark's financial health, though we don't think it will be able to rely more heavily on debt to support distributions, particularly as credit metrics are likely to weaken.
High and rising electricity bills will keep the regulator keenly focused on minimising network profits. At present, it is attacking allowed returns and allowances to cover operating costs and tax.
Value has improved in the past couple of years. We now consider Spark fairly valued, offering a good yield balanced by a tough regulatory outlook. It trades at an 8% discount to our fair value estimate, and income-oriented investors could consider buying now.


Spark's Distributions Aren't Immune to Regulatory Attacks