Roy davidson, 16 November 2017

Stock Comment - Vector VCT

VCT owns and operates the Auckland electricity and gas distribution networks along with unregulated assets such as electricity meters throughout the country.

One key risk that VCT faces is reduced volumes on its network, as energy consumption declines. At the FY17 result VCT highlighted that while new electricity connections increased 0.9%, reduced consumption per household saw total consumption decline 0.5%. This is an ongoing trend with consumption per household having declined around 10% in the past decade. VCT’s current price-quality path is set until 2020. Beyond this, the construct of the regulatory regime will change from a price-cap to a revenue-cap, effectively meaning that VCT will have the ability to charge more per household if electricity consumption continues to decline (in line with recent trends). The change to regulatory methodology in 2020 should remove demand risk for VCT, and under current assumptions, should allow VCT to increase pricing.

The Technology division includes VCT’s electricity metering business, which is rolling-out smart meters under contract to the electricity retailers. VCT now provides smart metering to over one million premises throughout New Zealand and is leading the consolidation of the market. VCT is also focussing on growing its position in the Australian market. VCT also has a large focus on emerging technologies, such as solar panels, battery storage and electric vehicle charging, positioning it ahead of industry changes.

In November 2015, VCT sold its gas business (excluding Auckland gas distribution) for $952.5m to First State Funds. We believe VCT received a good price for the assets, with the sale price representing 1.3x the regulated asset base (on which regulated returns are based). Proceeds will be largely used to pay down debt, with earnings falling around 10%. However, over time the proceeds from the sale will enable VCT to invest in its growing Auckland electricity network and unregulated opportunities, increasing shareholder returns in time.

We regard VCT as a blue-chip company with a solid capital structure and a stable dividend policy. VCT represents an excellent defensive exposure to the infrastructure sector, with strong cash flows, an attractive dividend yield and low volatility earnings characteristics. It also offers modest growth opportunities through its unregulated technology business, including smart meters, battery solutions and recently purchased HRV. The company’s main geographic exposure is to Auckland, which is expected to grow its population significantly in the coming years. With prices for VCT’s regulated electricity assets now set for the next five years, we expect VCT to steadily grow its dividend in the coming years.

Risks to VCT include: 1) Rising interest rates, 2) changing technology, 3) regulatory risk.