INSIGHTS

WEEKLY COMPANY INSIGHT: MERIDIAN ENERGY

Roy Davidson, 5 September 2019

MEL030919 

Description

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 over 30% of New Zealand’s electricity from seven hydro and five 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 300,000 customers across its two brands, Meridian and Powershop. The Crown retains 51% ownership of MEL.

Industry structure favours integrated generator/retailer model over the long-term

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 offtake agreements at fixed prices, or through financial hedge sales and contracts for differences.

Special dividends until 2021

In recent years, with a strong balance sheet and cash flow generation, MEL has returned capital to shareholders via special dividends. The current capital management programme, for special dividends of 4.88cps per year, holds through to end CY21. While the company has not given formal guidance for dividends beyond current policy, we would expect to see a progressive rise in the ordinary dividend (which was 16.42cps in FY19). MEL’s financial position remains strong with FY19 net debt/EBITDA of 1.7x, using a normalised EBITDA it is currently at 2.0x.

Transmission pricing changes would significantly benefit MEL

The Electricity Authority is reviewing the rules that Transpower follows in setting the transmission pricing for the national electricity grid. Under the current model, 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. We expect MEL to benefit from a potential change in the Transmission Pricing Methodology (TPM) in FY20, allowing it to grow earnings ahead of its peers.

Outlook: MEL well placed

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

  1. regulatory change
  2. declining aggregate demand
  3. increased competition
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