Uncertainty swept out of the electricity industry
FOR an industry considered to be fairly stable, there has certainly been a lot of volatility in listed electricity company share prices over the last year. Some volatility has been selfinflicted, and some reflected outside events.
Last week the electricity industry overcame two key events that had been hanging over the sector like the ‘‘Sword of Damocles’’. With these two events resolved, investors now have greater certainty. Investors may see this as positive.
Firstly, Meridian Energy signed and extended a contract with the NZ Aluminum Smelter (NZAS) to provide 572MW of power a year until 2030.
There is an element of ‘kicking the can down the road’ with termination options still in place, however we do get some certainty until at least April 2017. While Meridian is the contracting party with NZAS, it has pulled into the fold other participants in the sector. Contact Energy, Mighty River Power, Genesis and TrustPower have all provided back to back contracts with Meridian for supply electricity at various quantities.
The two thermal generators, Contact Energy and Genesis, potentially had the most to lose if NZAS decided to leave. The outcome would have been an oversupply of generation capacity, with higher cost thermal plant generation struggling to compete with low cost hydro generation. As a consequence, both of these parties had a vested interest in being key suppliers with 80MW and 50MW generation contracts with Meridian, respectively. At the margin, these deals will have a negative impact on company earnings for Genesis and Contact, but compared to an NZAS exit they are immaterial.
The clearing of this event then opened the door for the highly anticipated sell down by Origin of its 53 per cent stake in Contact. This deal had been speculated for some time, with key signposts from Contact when it emptied its imputation credit account, changed the dividend policy, and back-flipped on the international geothermal experiment.
Pressure within the Origin camp from credit rating agencies was another factor as Origin sought to improve its own financial flexibility.
The $1.8 billion sell down of Origin’s stake in Contact Energy was widely sought after by the investing community. The deal was completed at a substantial discount to the prevailing market price. The transaction may also transform the company.
Contact will now become the largest investible electricity company listed on the NZX, overtaking Meridian, and it will see a more diverse range of shareholders on the register, particularly some global infrastructure and pension funds, but also other fund managers. The company will also have a dual listing on the Australian Stock Exchange (ASX). The utility sector will now make up a substantial part of the New Zealand market at around 13 per cent.
Positively, current Origin chief executive secondee Dennis Barnes will transition to a Contact employee and remain as chief executive. Barnes is well regarded in the market and will be critical as the company transforms and evolves its strategy.
Importantly, the Contact board will go through a major transformation.
The three Origin directors will step down and a search will begin for replacements. This move to an independent board is a clear positive outcome from the sell down.
There is now also more clarity on the dividend policy for Contact. The company will support increased distributions to shareholders and target ordinary dividends equivalent to 100 per cent of underlying profit after tax. This will also be taken positively by shareholders.
In a week of several key events, there has now become greater certainty within Contact Energy and the broader industry.
With concerns about governance and supply contracts mostly addressed, we can now move back to focusing on the potential earnings and dividends for these companies.