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>Z Energy</h2>
Risk Ratchets Down, Slightly
The Commerce Commission’s (ComCom) final Retail Fuel Market Study report has found that the sector is overearning and its key recommendation is the implementation of terminal gate pricing (TPG). These findings were fully expected. The Government has indicated that it plans to implement most, if not all, of the ComCom’s recommendations and hopes to have enabling legislation completed by the middle of 2020. In our view, the findings reduce regulatory risk and our main concern is current retail market competition (which has a degree of irony).
What’s changed?
<ul>
<li>EBITDAF, target price &amp; rating: Unchanged - $389m, $5.11 &amp; NEUTRAL</li>
</ul>
Regulatory risk reduced
The ComCom’s findings and recommendations were expected. The only notable change from the draft report was recommending the introduction of TGP instead of opening up the industry “borrow &amp; loan” arrangements. It has also recommended that supplier/distributor contracts be non-exclusive and the contract length shortened. In essence, all of the ComCom’s recommendations were part of ZEL’s submission and three out of the four largest fuel retailers advocated for TGP. Whilst the ComCom believes the opening up of the wholesale market will improve retail competition (and lower retail fuel prices), we are less convinced.
Political risk also down, sort of
The Government has quickly come out and accepted the ComCom’s findings. Whilst it still has to go to Cabinet, indications are that the Government will look to implement the ComCom’s recommendations. That is a positive as it removes the risk of the Government doing something different. There are two caveats though. First, the Government wants to pass legislation by the middle of next year, which is very quick and runs the risk of poor legislation and a shortened consultation period. Second, the Government has high expectations that the recommendation will significantly lower pump prices — we are not convinced.
Retail risk remains
In our view, retail market competition is doing a very good job lowering retail prices at present. ZEL confirmed today that retail trading conditions remain very tough which, heading into New Zealand’s main holiday season, is of concern.
We estimate that at present the retail performance is between -$45m and -$50m below original guidance. If conditions do not improve the current trajectory suggests the retail EBITDAF will be ~-$80m below original guidance or ~-5cpl, equating to FY20 EBITDAF of ~$380m, -$10m below the bottom of the updated guidance range. We estimate that the current share price assumes an additional permanent reduction in the retail margin of between -3cpl and -4cpl. Whilst it is our view that the market is overly negative, until the retail market shows signs of improvement, it is hard to see a catalyst for a material positive re-rating as further earnings downgrades cannot be ruled out.&nbsp;
<div class="content-highlight">
Investment View
Our rating is NEUTRAL. Whilst ZEL entices investors with a very attractive dividend yield, challenges in the retail market means further earnings and therefore dividend downside cannot be ruled out. We believe ZEL has to, once again, demonstrate to the market it is able to deliver sustainable earnings, preferably with less volatility than the past two years.&nbsp;
</div>
Andrew Harvey-Green andrew.harvey-green@forsythbarr.co.nz +64 4 495 8185

Z Energy
Risk Ratchets Down, Slightly
The Commerce Commission’s (ComCom) final Retail Fuel Market Study report has found that the sector is overearning and its key recommendation is the implementation of terminal gate pricing (TPG). These findings were fully expected. The Government has indicated that it plans to implement most, if not all, of the ComCom’s recommendations and hopes to have enabling legislation completed by the middle of 2020. In our view, the findings reduce regulatory risk and our main concern is current retail market competition (which has a degree of irony).
What’s changed?

EBITDAF, target price &amp; rating: Unchanged - $389m, $5.11 &amp; NEUTRAL

Regulatory risk reduced
The ComCom’s findings and recommendations were expected. The only notable change from the draft report was recommending the introduction of TGP instead of opening up the industry “borrow &amp; loan” arrangements. It has also recommended that supplier/distributor contracts be non-exclusive and the contract length shortened. In essence, all of the ComCom’s recommendations were part of ZEL’s submission and three out of the four largest fuel retailers advocated for TGP. Whilst the ComCom believes the opening up of the wholesale market will improve retail competition (and lower retail fuel prices), we are less convinced.
Political risk also down, sort of
The Government has quickly come out and accepted the ComCom’s findings. Whilst it still has to go to Cabinet, indications are that the Government will look to implement the ComCom’s recommendations. That is a positive as it removes the risk of the Government doing something different. There are two caveats though. First, the Government wants to pass legislation by the middle of next year, which is very quick and runs the risk of poor legislation and a shortened consultation period. Second, the Government has high expectations that the recommendation will significantly lower pump prices — we are not convinced.
Retail risk remains
In our view, retail market competition is doing a very good job lowering retail prices at present. ZEL confirmed today that retail trading conditions remain very tough which, heading into New Zealand’s main holiday season, is of concern.
We estimate that at present the retail performance is between -$45m and -$50m below original guidance. If conditions do not improve the current trajectory suggests the retail EBITDAF will be ~-$80m below original guidance or ~-5cpl, equating to FY20 EBITDAF of ~$380m, -$10m below the bottom of the updated guidance range. We estimate that the current share price assumes an additional permanent reduction in the retail margin of between -3cpl and -4cpl. Whilst it is our view that the market is overly negative, until the retail market shows signs of improvement, it is hard to see a catalyst for a material positive re-rating as further earnings downgrades cannot be ruled out.&nbsp;

Investment View
Our rating is NEUTRAL. Whilst ZEL entices investors with a very attractive dividend yield, challenges in the retail market means further earnings and therefore dividend downside cannot be ruled out. We believe ZEL has to, once again, demonstrate to the market it is able to deliver sustainable earnings, preferably with less volatility than the past two years.&nbsp;

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

Z Energy Ltd

Z Energy: Risk Ratchets Down, Slightly