MCY Mercury NZ ( MRP Mighty River Power)

[Snow Leopard]

I go overseas every year. Solar is everywhere and privately owned. The CUSTOMERS do not like the electricity industry,they are viewed as rip off merchants and customers are starting to get choice.

I am permanently in that place you call overseas and move around it quite a lot.

I saw a lot of solar panels in some cities in North Korea, and on the roofs of many a ger in Mongolia.

And yes in some other places you see solar installs to some degree.

But everywhere?

Best Wishes
Paper Tiger

[Snoopy]

I assume MRP claims depreciation on their dams and geothermal assets for tax purposes but they need to record a "fair value" for their assets for the presentation of the financial statements. Fair value is established using NPV and the assets are revalued up especially when interest rates are so low as interest rates form part of the capitalisation rate (low cap rate high asset value). There is no tax paid or imputation credits created by the revaluation but they recognise that if the assets were sold it would create an equivalent amount of income in the form of depreciation recovered so the revaluation is shown in equity after tax. That is my best guess but anyone can feel free to point out any errors in my theory.

Capital out of "thin air" watch it disappear again if interest rates start to rise and the capitalisation rate increases. You would have seen this with AIA with the return of capital. To me it looks like AIA borrowed real money to pay shareholders the asset revaluation increase(capital return). Also you see it all the time with property company revaluations. Interest rates fall, cap rates fall and assets increase in value. If interest rates rise it all heads the other way.
You shouldn’t see an allowance for tax (depreciation recovered) on property valuations anymore as they can no longer claim depreciation on buildings for tax purposes.
Large companies like these will have a tax fixed asset schedule and the one we see in the financial statements. Any tax deferred should be shown in the financial statements. In the case of MRP the tax deferral is indefinite as the assets are never likely to be sold.
The roughly $83mill tax paid on profits would be more than enough imputation credits for the dividends paid.
Property and asset revaluations would not incur any income tax. They are accounting journals based on subjective valuations that is one of the reasons we have a cashflow report.

I remain fascinated with this method of creating wealth out of 'thin air', that MCY seems to have perfected. On page 56 of AR2016, the company accountants have this to say:

"Property plant and equipment is held on capital account for income tax purposes. When assets are revalued, with no similar adjustment to the tax base, a taxable temporary difference is created that is recognised in deferred tax. The deferred tax liability on these revaluations is unlikely to crystallise in the forseebale future under existing income tax legislation."

I presume that when assets are revalued, there is almost never an adjustment to the tax base. After all assets are just that: A means to an income, but not an income in themselves. Nevertheless Items on the 'capital account' are certainly 'real' and can be found in the balance sheet. And those 'revalued items' can be borrowed against for real cash.

Somehow the valuation process is done on the basis that the revalued assets might be immediately sold (?). I can't explain the revaluation associated 'deferred tax liability' any other way. In practice, selling one of the Waikato river hydro dams would be unthinkable for Mercury.

Aaron, above, reckons that such an 'unthinkable sale' would generate depeciation recovered income, if the sale price of our dam is well above depreciated value (which it would be). That makes more sense than just assuming that any dam sale would be subjected to some 'capital gains tax'.

It's a magic trick, some would say. Yet in this case the rabbit from the top hat has once again found itself in the Mercury accounts.

From the 'Consolidated Income Statement' , AR2016 p48, NPAT = $160m remains untainted. However, go down to the 'Statement of Comprehensive Income' and under 'Other Comprehensive Income' you will see a list of 'Items that will not be reclassified subsequently to profit or loss'.

There you can see a not insignificant positive $106m 'Movement in Asset Valuation Reserve'. It so happens that if you multiply $106m by the company tax rate you get:

$106m x 0.28 = $30m

Perhaps then it is not a co-incidence that just two lines down in the 'Other Comprehensive Income' you will see in the list of 'Items that will not be reclassified subsequently to profit or loss' there is a 'tax effect' entry of -$30m. So could this be the 'taxable temporary difference is created that is recognised in deferred tax' that I referred to above? If you go to note 6 in AR2016 (p56) you will find the report section on deferred tax. Go the row header labelled 'Property Plant and Equipment'. Look at what has happened to the liabilities between FY2016 and FY2015:

($1171m)-($1149m) = ($22m)

Note this doesn't match the $30m 'tax effect' referred to above. So what's going on? Further down page 56 shows this ($22m) is made up of three added figures:

A charge to the income statement	$13m
A credit from other comprehensive income	($38m)
Other movements	$3m
TOTAL	($22m)

So what does this mean and does it even matter? I can only answer the latter bit of my own question. If the declared NPAT is $160m, but this figure doesn't include a balance sheet boosting net revaluation gain of $76m (approximately half of the declared profits), then shareholders should find out about this $76m 'hidden benefit'. Is the real result for FY2016 effectively 50% higher than the declared result? That is a question that needs answering.

SNOOPY

[horus1]

The reason the Generators have dropped may be delays to Transmission Pricing changes. Thank goodness getting consumers to pay to get the power to the market hasnt happened. Hope it never does.

[Jantar]

...Thank goodness getting consumers to pay to get the power to the market hasnt happened. Hope it never does.

It already happens, just in a less equitable manner. Everything that the consumer uses, the consumer pays the transport costs in one way or another.

[GTM 3442]

I go overseas every year. Solar is everywhere and privately owned. The CUSTOMERS do not like the electricity industry,they are viewed as rip off merchants and customers are starting to get choice.

Interestingly, through the Middle East, there is a split between solar panels, and concentrated, molten-salt installations. The panels have the downside that they need constant dusting, even with (Dow-Corning's?) clever dust-repellent glass.

The molten-salt installations share that downside, but have the upside that they provide 24-hour solar.

As for Europe, the U.K., the Nordics and the Baltics, littered with panels. Presumably the incessant rain takes care of the dust, as it would for much of New Zealand.

Any reports from the Americas or Africa?

[Snoopy]

In general a 'special dividend' is not sustainable. If it were, it would be part of the regular dividend. The last five years is IMO the best yardstick we have of what the potential for regular income might be. This includes good and bad years and is, in my view, a better way of looking at things than trying to guess what weather conditions will be like "next year". The eps record is as follows:

Year	eps (normalised)
2011	11.5c
2012	10.8c
2013	12.0c
2014	13.3c
2015	11.1c

I get an average of 11.74cps. Buying on a 6% gross yield that I regard as 'about right' given current interest settings and a low to no growth demand environment gives an implied share price of:

11.74/ (0.06 x 0.72) = $2.72

I note the current trading price is $2.77. So even if the current dividend yield is sustainable, I don't believe the share price is cum an 8.4c final dividend combined with 2.5c special (ex dividend price is an implied $2.66).

As of last year I am using FY2011 as the first year that Mercury 'back then' resembles Mercury today. FY2011 was the first year for the giant "Nga Awa Paroa" (128MW) geothermal station being on line. "Nga Awa Paroa" virtually doubled the geothermal generation capacity of Mercury at the time. It was also the first year that the new HVDC north south cable link was completed. So I have chosen FY2011 as the first year in Mercury's 'modern' power generation era for modelling purposes.

Year	eps (normalised)	dps (ordinary)	dps (special)
2011	11.5c	6.79c	0c
2012	10.8c	8.60c	0c
2013	12.0c	8.01c	0c
2014	13.3c	12.4c	0c
2015	10.1c	13.9c	5.0c
2016	11.1c	14.1c	2.5c
Total	68.0c	63.9c	71.4c
Average	11.5c	10.6c	11.9c
			(Total and Average of Normal+Special)

Based on the same 6% gross yield that I used for FY2015, I can calculate three capitalised earnings valuations for MCY.

11.5/ (0.06 x 0.72) = $2.66 (based on averaged, normalised eps)

10.6/ (0.06 x 0.72) = $2.45 (based on averaged, normalised ordinary dps)

11.9/ (0.06 x 0.72) = $2.75 (based on averaged, normalised total dps)

This year I am calculating all three valuations, because I wanted to show there is no one 'right answer'. The 'right answer' depends what you want to look at. My preferred answer is $2.66. That calculation assumes that 100% of cumulative earnings will eventually be paid out as dividends. This is what we shareholders have observed has happened. This answer is no more 'valid' than the $2.45 valuation, based only on the ordinary dividends that have actually been paid.

There is an extra 'hidden value' contained within MRP though. This hidden value is aligned with the 'thin air capital' that Mercury creates, and that I have referred to in previous posts. One argument is that Mercury delivers the extra value of this 'thin air capital' via special dividends to optimize the capital structure of the company. If you agree with that proposition, then you can make a case for the company being worth the third higher $2.75 valuation. Personally I prefer to see the value of this 'thin air capital' reflected in a different way.

SNOOPY

[Snoopy]

A couple of interesting statistics from FY2012, a year without an unusual river inflow. Mighty River Power had a 51.4% capacity utilisation from their hydro stations and a very impressive 94% capacity utilisation from their geothermal stations. This gives an idea of the relative importance of the two kinds of generation in relation to total energy generated by MRP. Since the commissioning of the latest geothermal station (Ngatamariki) in 2013/2014, MRP have enough revalued capital on the books to build yet another 'free' geothermal power station if they so choose. Let's say this potential new station could deliver 100MW. By how much would that increase the base generating capacity of MRPs portfolio?

1044MW Hydro (existing) x 0.514 = 537MW (effective)
463MW Geothermal (existing) x 0.940 = 435MW (effective)
100MW Geothermal (new) x 0.940 = 94MW (effective)

Hence the effective new power generation capacity increase is:

94 / (537+435) = 10%

OK that new power station is not yet built, or even hinted that it will be started. But I would argue that MRP already has this new hidden value built into the company. The company is effectively 10% bigger than its current production capacity, and could up size by 10% seemlessly if management so chose to do it.

So I take my previous valuation based on eps flow alone:

11.74/ (0.06 x 0.72) = $2.72

and up it by 10% to take account of the power station on the books that could be built now:

$2.72 x 1.1 = $2.99

By my reckoning $2.99 is my best 'investment estimate' of where the value of MRP sits right now.

I am going to use the assumption that, following the completion of the most recently commissioned Ngatamariki geothermal station in FY2013, Mercury considered itself 'capital optimised'. Using the balance sheet from that year, we can therefore calculate an optimised gearing ratio for the company:

Optimised Gearing ratio: (Total Liabilities)/Total Assets): $2,620m / $5,802m = 45%

The 'thin air capital' accumulated by Mercury since FY2013 is as follows:

Year	New Thin Air Capital	Post Tax Effect Multiplier	Effective New Thin Air Capital
FY2014	$40m	0.72	$28.8m
FY2015	$497m	0.72	$357.8m
FY2016	$106m	0.72	$76.3m
Total			$463m

The total of this 'thin air capital' that has been accumulated could theoretically support extra debt 'd' according to the company's optimised gearing ratio.

'd' / $463m = 45% => d=$209m

We thus have a total of amount of: $463m + $209m = $672m available to build a new geothermal power plant. Compare this to the $475m cost of building the Ngatamariki 85MW thermal plant in FY2013. I think there should be enough capital available to build a new 100MW plant in FY2017, provided Mercury has not returned any of this 'thin air capital' to shareholders in the meantime.

I should point out that Mercury currently has no plans to build such a plant. I am merely pointing out that they could. Furthermore because they have the relevant consents, eventually I believe they will. So how do we reflect the potential to build this new power station in today's valuation? This will be determined by the 'effective power generating capacity' ( maximum capacity x expected time ultilisation ) of all of the existing generation capacity.

1044MW Hydro (existing) x 0.514 = 537MW (effective)
463MW Geothermal (existing) x 0.940 = 435MW (effective)
100MW Geothermal (theoretical new) x 0.940 = 94MW (potentially effective)

Hence the potential effective new theoretical capacity increase is:

94 / (537+435) = 10%

Since the overall market would have expanded by the time this new station was commissioned, I would argue that this thin air capital generated since EOFY2013 represents an increase in value of 10% based on the underlying worth of the company today. So my final EOFY2016 valuations are:

$2.66 x 1.1 = $2.93 (based on averaged, normalised eps)

$2.45 x 1.1 = $2.70 (based on averaged, normalised ordinary dps)

Note that I have not incremented my third valuation of $2.75 which included special dividends. In my assessment the 'special dividends' are effectively a return of capital, or more specifically a 'return of thin air capital'. Thus putting an incremental multiple on that figure would be equivalent to 'double counting'.

Summary:

I value MCY as worth between $2.70 and $2.93 (ex-dividend). At $2.93 on the market today, I consider MCY to be at the top end of fair valuation. It is nowhere near high enough for me to consider selling though. By contrast if I was buying, I always like to buy in slightly below fair value. My target buy in price, based on a dividend yield of 6.5% would be:

$2.49 to $2.70.

Right now, I'm neither selling nor buying.

SNOOPY

discl: hold MCY

[Snoopy]

Year	eps (normalised)	dps (ordinary)	dps (special)
2015	10.1c	13.9c	5.0c
2016	11.1c	14.1c	2.5c

Based on the same 6% gross yield that I used for FY2015, I can calculate three capitalised earnings valuations for MCY.

11.3/ (0.06 x 0.72) = $2.61 (based on averaged, normalised eps)

10.6/ (0.06 x 0.72) = $2.45 (based on averaged, normalised ordinary dps)

11.9/ (0.06 x 0.72) = $2.75 (based on averaged, normalised total dps)

This year I am calculating all three valuations, because I wanted to show there is no one 'right answer'. The 'right answer' depends what you want to look at.

Eagle eyed readers will have noticed that I changed my 'normalised earnings' number for FY2015 in FY2016 (down from 11.1c to 10.1c), verses the earnings I quoted in FY2015 for FY2015. There is always some judgement involved deciding what part of the profit is 'normal' and what is 'not normal'. Reading the Annual Report for FY2016 (Note 3), I became aware that non-core property sale profits of $17m (FY2015) and $13m (FY2016) were included in the EBITDAF profit figures for the year. This is confirmed by slide 35 of the annual results presentation. Here it states that no further land sales are forecast to contribute to EBITDAF in FY2017.

I think it is disappointing that when contriving EBITDAF, to assess the 'normal' cashflow of the company, Mighty River has decided to include surplus land sales as part of 'normal'. This is IMO distortionary if you are trying to form a view of the company's 'normal' (power generation) operations.

Counter to this we learn that there was an extra $18m worth of capital expenditure, not included in the $72m of capital expenditure for FY2016 declared as such. This extra CAPEX was related to remediation of some land in relation to an investment already exited in Chile. Should I count that as 'normal'?

SNOOPY

[Snow Leopard]

The Eagled-Eyed would spot that Mercury provide you with 'Normal' but they do call it 'Underlying Profit' or some such.

Best Wishes
Paper Tiger

[Aaron]

I'll have to check your figures later Snoopy. Just logging in say I guess the lack of a huge price drop means the earthquake was too far South. I am currently holding way too many MCY shares after the world deciding interest rates and bonds/dividend yielding companies have reached the bottom, right after I bought some extra shares to dividend strip the last bonus dividend, the plan was to have these sold to strip the Meridian bonus dividend later that same month(too greedy waiting for the price to recover). Anyway fallback position is three dividend payments in little over twelve months and see whether the financial world hasn't crashed. MCY's price should be underpinned by its ability to generate income and pay dividends. A North Island earthquake could stuff MCY quite badly. I guess there are no major dams near where the earthquake was centered down South for MEL shareholders.

Apologies for selfishly thinking about myself while many down South are suffering.