Roy Davidson, 7 December 2017

Meridian stock comment 

Meridian Energy is New Zealand’s largest electricity generator and has a 100% renewable generation platform. It owns and operates New Zealand’s largest portfolio of hydro and wind generation assets and generates about 30% of New Zealand’s electricity from seven hydro and four wind facilities. MEL’s generation and retail portfolio is carefully managed to reduce earnings volatility that can arise from adverse hydrological conditions. MEL has over 270,000 customers across its two brands, Meridian and Powershop. The Crown retains 51% ownership of MEL.

Wholesale electricity pricing can be very volatile, as it is driven largely by the levels of (and flows into) the hydro dams. The New Zealand electricity market is dominated by a small number of integrated generator/retailers. While the generators sell most of their power into the grid and through the wholesale market, the price that they receive for their generation is not materially dependent on the relatively volatile wholesale price. This is because about 90% of their generation is hedged, either naturally via retail off-take agreements at fixed prices, or through financial hedge sales and contracts for differences.

MEL delivered a solid FY17 result despite weaker inflows into its South Island dams during a prolonged dry period, demonstrating the strength of the company’s operations. MEL announced another special dividend of 2.44 cents per share as part of its targeted the progressive return of $625m to shareholders over the next five years. This special dividend carries no imputation credits. The board believes special dividends (which will all be unimputed) are currently the most equitable way of distributing this capital. A key piece of news heading into the result was the retirement of well-regarded CEO Mark Binns, with Neal Barclay appointed to the top job from within the company.

The Electricity Authority is reviewing the rules that Transpower follows in setting the transmission pricing for the national electricity grid. One issue that has emerged in recent years is that power from North Island generators is often transferred across the Cook Strait HVDC link when South Island hydro lakes are at low levels. North Island generators pay nothing for using the link to send their power south, as all costs are allocated to South Island generators. One of the options outlined by the Authority is to change the pricing methodology to rectify this, which would see South Island electricity generators (like MEL) benefit strongly from much lower charges.

MEL is one of the better managed New Zealand electricity companies paying a sustainable dividend, supplemented by the multi-year capital return programme, while it has the lowest debt leverage in the sector. MEL remains a core holding in the PWR New Zealand equities portfolio.

Risks to MEL include: 1) Rising interest rates, 2) regulatory change, 3) increased competition.