WEEKLY STOCK COMMENT: MERIDIAN ENERGY
Roy Davidson, 7 June 2018
Meridian Energy (MEL) 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.
Recent 1H18 result (despite dry South Island hydro) highlights the company’s ability to mitigate risks through difficult periods. Despite hydro volumes being down 16%, the energy margin was down just 7%. Retail electricity competition is creating some headwinds, but this is something we are seeing across the broader market, and not only in NZ. MEL has growth opportunities into the Australian market via its Powershop brand – early performance has been promising. The company’s current capital distribution policy is in place through to December 2019 but given its strong balance sheet, we could see this extended.
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.