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Risk v Reward: Mighty River v Contact

Investors weighing up the Mighty River Power share offer would do well take a peek at rival company Contact Energy.

The two companies are quite similar in terms of size and what they do, but it is the return on shares invested that is of most interest, now that the government has released financial forecasts and key investment metrics in offer documents for the Mighty River partial float.

The government expects to raise up to $1.9 billion from the sale of 49% of Mighty River with the 686 million shares expected to be priced somewhere between $2.35 and $2.80 each.

The final price to be set following an institutional bookbuild could be higher or lower than that range, and Finance Minister Bill English did acknowledge yesterday that uncertainty over the future of the Tiwai Point aluminium smelter, which takes 13-15% of the country’s electricity, may be a factor here.

The price range is slightly lower than the speculation in the market leading up to yesterday’s announcement, possibly as a result of the Tiwai issue, now seen as a key risk for investors to decipher given the potential downward pressure any closure is likely to have on domestic electricity prices.

Mighty River is expecting a sharp rise in profits after suffering heavy writedowns on its offshore geothermal investments last financial year, but is expecting its underlying earnings to be flat this year before declining again in 2014. The company is looking forward to the full commissioning of its new 82MW Ngatamariki geothermal power station to better balance its portfolio against dry conditions such as being experienced now.

Based on the numbers, Mighty River is forecasting gross annual dividend yields of between 6% and 7.7% this year and next, and earnings per share of 6.77c in the current year.

Based on the price range, Mighty River will trade at a price earnings multiple of between 34.7 times and 41.4 times for the current year, falling to between 20.5 times and 24.4 times in 2014.

MRP v CEN
So then, lets compare these metrics with Contact Energy, which has been publicly listed since 1999 with a free float of 47.5% (Australia’s Origin Energy owns the other 52.5% of the company).

Contact produced a solid performance for the December half year, with after tax profit up 29% at $88 million. (Full year 2012 was $190.4 million and some analysts are expecting something similar this year).

The half-year result was achieved despite weakness on the wholesale electricity market and sustained competition in the retail market.

Forsyth Barr analyst Andrew Harvey Green reckons Contact’s half-year results showed the benefits of the company’s diverse asset portfolio and operational flexibility.

Contact's asset portfolio is made up of 50% thermal, 22% geothermal and 28% hydro. (Mighty River currently has 61% Hydro, 31% geothermal and 8% gas, although geothermal will rise above 40% once Ngatamariki is fully commissioned shortly).

Mr Harvey Green noted at Contact's half year announcement notes that the company has already outlined the possibility of increased capital returns following the completion of Te Mihi Power Station.

Te Mihi brings to an end a more than $2 billion investment programme adding lower cost geothermal and more flexible thermal generation capacity. (Contact has also and New Zealand’s first gas storage facility.)

By the numbers
Getting down to brass tacks, at its current share price of $5.50, Contact earns investors a gross dividend yield of 6.03%, has earnings per share of 29c and a PE ratio of 18.64 times.

However, based on Forsyth Barr’s 12-month target price of $6.10, Contact has a forecast 2014 gross yield of 8.7%, rising to 9.3% in 2015.

Over at Mighty River, at a share price of $2.35 investors can expect a gross yield of 7.1% for the current year, rising to 7.7% in 2014.

At $2.80, the yield is 6% increasing to 6.4% in 2014.

Put against Mighty River Power’s forecasts, Contact therefore looks quite attractive.

Looking at the figures, accountant Bruce Sheppard tells NBR ONLINE this: “Umm, investors can decide if the return premium justifies the risk.”

Demand v Supply
In more general terms, the electricity sector is quite uncertain.

As Forsyth Barr’s Harvey Green notes, the demand outlook remains weak, albeit with some signs of modest growth.

The threat of closure of industrial plants like Tiwai is an issue that is not going away anytime soon.

In fact it now seems likely that the government is favouring a “managed exit” of Tiwai Point and Prime Minister John Key is now unlikely to give any significant concessions to Rio Tinto, tempting as it may have been prior to setting the MRP price range.

Rio and Tiwai supplier Meridian Energy are scheduled to get together next week in what looms as a crucial meeting.

While Mighty River is forecasting an uptick in profits, its underlying earnings are stagnant through 2013 and are forecast to actually decline in 2014.

Mighty River notes that its exposure to the wholesale spot market varies “half hourly,” daily and throughout the year.

Much depends on Lake Taupo storage levels, Waikato catchment inflows, national hydrological conditions and market factors.

As such, right now Mighty River is having to rely much more on geothermal as hydro levels are seriously effected by the drought (Lake Taupo is at historic lows).

All these factors are listed in the offer document’s risk section.

Hence Mighty River is trumpeting the full commissioning of Ngatamariki, which will take the company’s geothermal contribution to above 40%.

Mighty River Chairwoman Joan Withers says the share float is exciting and heralds a new era for the company. The number of New Zealanders pre registering for the offer is very encouraging, she says.

But as Mr English says, potential investors must weigh up the risks themselves.

dbridgman@nbr.co.nz

More by Duncan Bridgeman

Comments and questions
10

Do any analysts expect a drop in CEN as investors rebalance their portfolios after adding MRP so as to not have over exposure to energy assets?

Can i ask a stupid question... what was an SoE doing investing offshore anyway? that is acting like a private corporate entity not an SoE in my books...

Hard to understand why so many dislike a question?

I think they are still expected to return as much profit as possible to their shareholder, just happens to be the Govt.

Wasn't Solid Energy run into the ground for the same reason?

I think the analysis might work out something like this, but I'm not advising anyone and I'm still not sure myself:

1. Is there upside in the earnings of MRP? answer Yes, ...why

1.1 ensure current CEO leaves, focus solely on core NZ generation business, no gas exploration, and no flirting with interest rate derivatives, return to banking reliable and more predictable cash flows, work out how to compete for a future Manapouri supply, displace expensive marginal generation costs and avoid passing on any price savings to customers .

1.2 take a Graeme Hart approach to every employee earning over $100k pa who doesnt have dirty finger nails.

ok if that could happen what should I pay?

2. How the float may actually work.

2.1 B Gaynor wisely suggests in today's column a trigger price of $2.50

2.2 this is because bids have to be for $2,000 plus of shares, and at $2.50 thats easy, for a $2,000 minimum.

2.3 because when you add the 25% extra allocation for preregistration = $2,500 worth = 1,000 shares per Kiwi.

2.4 400,000 x $2,500 = $1billion [total float value about $1.4bn, add some insto allocation and some people to get more than $2,500 worth and the deal is done.

3. Valuation of government 51% if shares trade up to $3 [as the business plan in 1 above is implemented] = $1.75bn

4. So not too far off the current carrying value of the SOE and Govt can tax back around 30% of the $300m implied "stag" and the float fees pool.

QED

You may want to review your info about the 25% "extra" allocation for pre-reg.-and then all your other calculations following that. I think you're confused with one extra share for every 25 held after two years? That's 4%.

If the minimum subscription is $2000 worth then that is the lowest allocation that can be made to Joe Public (assuming he was not pre-registered). If the 25% more for pre-registration promise is met then the minimum allocation to those 440,000 who did pre-register must be $2500. [I assumed 10% will drop out or are duplicates that will be weeded out.] This is different from the 1 for 25 loyalty hang in there bonus in two years.

If you have 1000 shares then the bonus is 40 shares. The maximum bonus is 80, so it seems some investors may be getting closer to 2000 shares.

So the over-analysis is superficial and simple but it's easy to follow and - hey - these shares are being sold by politicians.

I think what is being pointed out here to you is that the 25% you mention does not apply to balances up to the first 2k. Thus the minimum application amount is not 2.5k just because you have registered. Have a read of the details. All they are saying is that if it is scaled and you have applied for more than 2000 shares, then you will receive 25% more than someone who did not pre-register. Further maximum bonus shares are 200 - i.e, for an applicant buying and holding 5000 shares.

buy both

anon re SoE - a good example of it done well

30 November 2005 - Meridian completed the sale of its Australian operation, Southern Hydro, for A$1.42 billion (NZ$1.52 billion) to Australian Gas Light Company. Meridian had steadily expanded and upgraded its assets in Australia since purchase, including commissioning a 91 MW wind-farm. The sale commanded a hefty premium, driven by new demand for renewable energy-generation because of mandatory Australian requirements that electricity retailers sell a proportion of renewable energy.

MRP rearranged it's overseas geothermal projects so could still produce growth? Sticking to NZ probably won't produce much growth in a oversupplied market especially if Tewai goes. Is there any serious hope of producing much growth in Chile & the States if it came off? What are the figures, cos what chance has CEN to grow much?