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>Vector</h2>
ComCom WAC<a target="_blank"></a>Cs Electricity Price
The Commerce Commission (ComCom) has reset Vector’s (VCT) maximum allowable electricity revenue -6% lower for the regulatory year to 31 March 2021. The price cut was expected in light of the low interest rate used to set the regulated weighted average cost of capital (WACC). Looking ahead, the key decisions for VCT are what it does with its dividend and whether it applies for a customised price path (CPP).
What’s changed?
<ul>
<li>Earnings: No change to near-term earnings</li>
<li>Target Price: Unchanged at $3.20</li>
<li>Rating: UNDERPERFORM rating retained</li>
</ul>
ComCom regulatory price reset in line with expectations
The ComCom’s starting price point for VCT’s regulated electricity revenue is slightly lower than the ComCom’s draft September 2019 calculation, with the main difference coming from a lower regulatory opex and capital allowance. The key point is that revenue will be ~-$25m lower in the year to 31 March 2021 relative to the prior year — in line with expectations.
VCT Board yet to determine dividend implications, CPP possible
VCT has again indicated that the Board “will review its dividend policy and approach to capital projects”. At the latest, an announcement regarding dividend policy will be made at VCT’s 1H20 result in February 2020.
Our assumption is that the Board will maintain dividend growth of +0.25cps per annum, but will move to partially impute the dividend to 70%. If the Board does not alter the dividend policy it risks a credit rating downgrade to BBB- as its credit metrics get very close to S&amp;P’s lower threshold boundary.
VCT has other decisions to make around whether it applies for a CPP and/or increase its up front capital contribution requirements from developers. VCT had been seeking a material increase to its capex allowance, however, the ComCom caps any capex allowance increase at +20% — meaning VCT’s capex allowance is -$189m (~-$38m per annum) below what VCT had been seeking. Applying for a CPP would allow VCT to seek a higher capex allowance, but comes with significant downside in the form of management distraction and there is no guarantee the ComCom will allow higher capex.
Potential uplift from higher market risk premium, but in five years
Last week the ComCom released its draft regulatory decision for fibre. In it, the ComCom’s WACC advisor recalculated the market risk premium (MRP), increasing his estimate to 7.5% from 7.0%. The electricity price reset uses the current MRP estimate of 7.0%, hence, there is upside potential at the next regulatory price reset (in five years). A 7.5% MRP adds ~+0.18% to VCT’s WACC (~+$10m to EBITDA). However, the draft fibre decision is undergoing consultation. There is a risk the draft decision does not stick, and/or when input methodologies are reset (in three years), the MRP estimate drops back to 7.0%.&nbsp;
<div class="content-highlight">
Investment View
Our rating is UNDERPERFORM. Whilst VCT offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.&nbsp;
</div>
Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185

Vector
ComCom WACCs Electricity Price
The Commerce Commission (ComCom) has reset Vector’s (VCT) maximum allowable electricity revenue -6% lower for the regulatory year to 31 March 2021. The price cut was expected in light of the low interest rate used to set the regulated weighted average cost of capital (WACC). Looking ahead, the key decisions for VCT are what it does with its dividend and whether it applies for a customised price path (CPP).
What’s changed?

Earnings: No change to near-term earnings
Target Price: Unchanged at $3.20
Rating: UNDERPERFORM rating retained

ComCom regulatory price reset in line with expectations
The ComCom’s starting price point for VCT’s regulated electricity revenue is slightly lower than the ComCom’s draft September 2019 calculation, with the main difference coming from a lower regulatory opex and capital allowance. The key point is that revenue will be ~-$25m lower in the year to 31 March 2021 relative to the prior year — in line with expectations.
VCT Board yet to determine dividend implications, CPP possible
VCT has again indicated that the Board “will review its dividend policy and approach to capital projects”. At the latest, an announcement regarding dividend policy will be made at VCT’s 1H20 result in February 2020.
Our assumption is that the Board will maintain dividend growth of +0.25cps per annum, but will move to partially impute the dividend to 70%. If the Board does not alter the dividend policy it risks a credit rating downgrade to BBB- as its credit metrics get very close to S&amp;P’s lower threshold boundary.
VCT has other decisions to make around whether it applies for a CPP and/or increase its up front capital contribution requirements from developers. VCT had been seeking a material increase to its capex allowance, however, the ComCom caps any capex allowance increase at +20% — meaning VCT’s capex allowance is -$189m (~-$38m per annum) below what VCT had been seeking. Applying for a CPP would allow VCT to seek a higher capex allowance, but comes with significant downside in the form of management distraction and there is no guarantee the ComCom will allow higher capex.
Potential uplift from higher market risk premium, but in five years
Last week the ComCom released its draft regulatory decision for fibre. In it, the ComCom’s WACC advisor recalculated the market risk premium (MRP), increasing his estimate to 7.5% from 7.0%. The electricity price reset uses the current MRP estimate of 7.0%, hence, there is upside potential at the next regulatory price reset (in five years). A 7.5% MRP adds ~+0.18% to VCT’s WACC (~+$10m to EBITDA). However, the draft fibre decision is undergoing consultation. There is a risk the draft decision does not stick, and/or when input methodologies are reset (in three years), the MRP estimate drops back to 7.0%.&nbsp;

Investment View
Our rating is UNDERPERFORM. Whilst VCT offers a solid dividend yield there is some downside risk to the gross dividend from low interest rates impacting on the electricity regulatory price reset. At this point in time we prefer other high yielding investments over VCT.&nbsp;

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

Vector Ltd

Vector: ComCom WACCs Electricity Price