Contact Energy - CEN Chart

[Beagle]

Hey Snoopy,

I got the 65% imputation credit from the latest dividend. F.Y.I. I didn't go back and look at previous imputation levels in earlier dividends.

For me the big unknown here is the dividends going forward. The extent to which the company is very clearly issuing a major caution about forward dividends without providing any guidance was enough to keep me sidelined so I bought more GNE instead. The tone of page 43 is cause for concern for a protracted and significant reduction in dividend level http://nzx-prod-s7fsd7f98s.s3-websit...656/328001.pdf

[Snoopy]

Hey Snoopy,

I got the 65% imputation credit from the latest dividend. F.Y.I. I didn't go back and look at previous imputation levels in earlier dividends.

Ah thanks for that. I see the 65% figure as a footnote on p56 AP2020. FYI the interim dividend for FY2020 of 16cps as paid on 7th April was imputed to 70% (69.82% to be exact). Last year (FY2019) the final dividend, paid on 17th September 2019, was also 23cps but that was imputed to 72.25%.

For me the big unknown here is the dividends going forward. The extent to which the company is very clearly issuing a major caution about forward dividends without providing any guidance was enough to keep me sidelined so I bought more GNE instead. The tone of page 43 is cause for concern for a protracted and significant reduction in dividend level http://nzx-prod-s7fsd7f98s.s3-websit...656/328001.pdf

You are right to be cautious. But maybe you should have read slide 38 on Contact's annual presentation for FY2020 as well.

"There appears no role for base load thermal generation post NZAS exit."

This means that Geneis's Huntly is dead, in less than a years time. Oh and from slide 33

"Premature decline of the oil and gas sector."

That doesn't sound very good for Genesis does it? It will be a blow if the recently upgraded gas field reserves become 'stranded assets'. Although from what I have seen in the comments on the NZ electricity market from Genesis's CEO Marc England, he seems to be in denial ( using the phrase 'if Tiwai Point closes' ). Given all of the big five gentailers are operating in the same market, I wouldn't be too reassured by Marc's up beat comments. But if the government can come to the party on transmission costs, maybe we can get another two or three years out of Tiwai? Marc 'the optimist' England might yet be right.

SNOOPY

[Snoopy]

Really Snoopy ? While my dividend payers have shrunk slightly, way less than I thought it might.
So far.

Maybe it is just my portfolio RTM. I have lost dividends from TRA (now paying again although I am not sure they should be) AWF, HGH (probably), SCT, SKC and PGW post Covid-19. Earlier I lost RBD as well (although the dividend cancellation there was nothing to do with Covid-19). I am only getting dividends from my utility shares now :-( and SKL :-). I seem to have made the switch from being an 'income' investor to a 'growth' investor without knowing it or doing anything!

SNOOPY

[RTM]

Maybe it is just my portfolio RTM. I have lost dividends from TRA (now paying again although I am not sure they should be) AWF, HGH (probably), SCT, SKC and PGW post Covid-19. Earlier I lost RBD as well (although the dividend cancellation there was nothing to do with Covid-19). I am only getting dividends from my utility shares now :-( and SKL :-). I seem to have made the switch from being an 'income' investor to a 'growth' investor without knowing it or doing anything!

SNOOPY

That's annoying. Yes, I am waiting somewhat anxiously as well on Heartland. Although I have not written them off and am expecting a smaller dividend rather than nothing.
My diversified portfolio has stood me in good stead to date. A lot of the commentary on ShareTrader has contributed to my decision making and I thank you all for that.
So far !
3 Stocks 5-8 %, 14 stocks 2.6-5%. 23 stocks 0-2.5%
Additionally CRAIGS convinced me that holding some bonds was a good idea. So I picked up some a few years ago and these are generally still returning a pretty attractive dividend. Of course it is a problem when they expire.

[Beagle]

You are right to be cautious. But maybe you should have read slide 38 on Contact's annual presentation for FY2020 as well.

"There appears no role for baseload thermal generation post NZAS exit."
This means that Geneis's Huntley is dead, in less than a years time. Oh and from slide 33

"Premature decline of the oil and gas sector."

That doesn't sound very good for Genesis does it? It will be a blow if the recently upgraded gas field reserves become 'stranded assets'. Although from what I have seen in the comments on the NZ electricity market from Genesis's CEO Marc England, he seems to be in denial ( using the phrase 'if Tiwai Point closes' ). Given all of the big five gentailers are operating in the same market, I wouldn't be too reassured by Marc's up beat comments. But if the government can come to the party on transmission costs, maybe we can get another two or three years out of Tiwai? Marc 'the optimist' England might yet be right.

SNOOPY

One leading broking house has GNE's dividends steadily rising each year to 18 cps in 4 years time. EBITDAF rising to $450m in three years time.
It'll take an quite some years for Manopouri power to find it's way up north and there are of course limits on inter island power transmission.
I think your statement that Huntly is dead in less than a years time misses the mark by quite a considerable distance.
I suspect a lot of gentailiers are talking their own book.

There's always going to be huge demand for gas and LPG, usage of these are deeply imbedded in the economy.
Just because Huntly might gradually wind down as GNE's wind power generation gradually winds up doesn't mean Kupe is a stranded asset, far from it.
I for one think its great N.Z. has about a 25 year supply of LPG and Gas...the massive upgrade to Kupe's reserves is a game changer and completely overlooked by the market, (other gentailiers have rallied more since that announcement as bond proxies).

[Snoopy]

There is no separate tax entry relating to 'Items that may be reclassified to 'profit and loss' (in particular 'movement in hedged reserve'). So I am not sure if tax for this has already been accounted for in the only 'Tax Expense' entry, or if there is no tax effect.

Here is what investopedia

https://www.investopedia.com/ask/ans...ive-income.asp

says about taxes on 'Other Comprehensive Income'.

"In regards to taxes, it is permitted to report other comprehensive income after taxes, or one can report before taxes as long as a single income tax expense line item is included at the end of the statement. Conversely, this can also apply to a tax benefit."

In the case of Contact Energy, there is no single income tax line at the end of the income statement. I therefore conclude that 'Other Comprehensive Income' is reported 'after taxes' and there is no 'extra tax' to report that would increase the amount of imputation credits available.

I want to look at the other part of EBITDAF that slides outside the normalised NPAT capture net. That factor is 'S', the contribution from special items. Yes I know that EBITDAF does not contain an 'S', but special items are definitely not in the EBITDAF picture.

Investopedia tells us that all tax, including that from 'Other Comprehensive Income', should appear in one line in the income statement. But as the table below shows, this is not the case for Contact Energy and the special profit items associated with one off transactions. The following table is compiled from below the 'Underlying Profit' line on the respective earnings break down in report section A2 of the respective annual reports, and after the 'Tax on Underlying Profit' has already been spelt out.

	FY2020	FY2019	FY2018	FY2017	FY2016
Change in Fair Value of Financial Instruments	$0m	$2m	$3m	$23m	($21m)
Gain of sale of Rockgas		$165m
Gain of sale of Ahuroa Gas Storage Facility		$5m
Remediation for Holidays Act Non-compliance	($5m)	$2m		($5m)
Transition to Replacement Customer Service and Billing System				($7m)	($10m)
Otahuhu closure and site sale					($217m)
Write down of inventory gas					($43m)
Asset Impairments					($38m)
Reinstatement of tax on Depreciation of Powerhouses					$4m
Tax on Significant Items	$1m	($5m)	($1m)	($2m)	$100m

A slightly annoying aspect of Contact's reporting over recent years is the tendency to round numbers up or down to the nearest million. This isn't a problem with big totals. But drilling down into the minutiae of results this policy can cause distortions.

Apart from FY2016, the extra tax paid, or refunded is small. But there are couple of other points that can be gleaned from this table.

1/ In FY2018 there was a tax bill that can only be associated with a 'Change in Value of Financial Instruments'. This shows that a 'Change in Value of Financial Instruments' is a taxable event: Tax Paid: $1m/$3m = 33% (could be 28% within rounding errors).

2/ Using similar logic over FY2020, 'Remediation for Holidays Act Non-compliance' is also a taxable event. This is not a surprise as wages are a tax deductible expense. Yet I am curious as to why the tax rate was only: $1m/$5m = 20%. (This may be another example of rounding error because $1.5m/$4.5m=33%, greater than the 28% I was expecting. So the real tax rate could still be 28%).

The very large elephant in the tax room is that $100m tax credit from FY2016. Now I am not a tax expert. But I do know that the tax return that is supplied to Inland Revenue and the tax treatment outlined to shareholders in the income statement of the annual report are not always the same. It could be that this $100m refund is tax that has already be paid but will not be refunded in one lump as just reading the income statement in the annual report implies. If instead the refund happens gradually over the normal depreciation life of those 'written off' Otahuhu generation assets, then Contact may have already paid more tax to the IRD than their reported earnings requires. And if Contact have paid more tax than their declared comprehensive tax position implies, that would mean they have a higher imputation credit balance on the books than shareholders might expect. That in turn might mean that dividends could be imputed to a higher rate than would otherwise be expected. Of course, any such tax balance differences between what is declared to the IRD and what is shown as the 'tax expense' in the income statement of the annual report will ultimately converge. But in the interim, the rate of dividend imputation on Contact shareholder dividend payments might have given shareholders a false picture of what dividend imputation rates are going to be possible looking forwards. I don't know if I am right about this. But there is some 'smoking gun' evidence in AR2016 that is not inconsistent with my theory.

From the Income Statement

Tax on Underlying Profit	($64m)
add Tax Refund on Significant Items	$100m
equals Total Tax (Refund)	$46m
compare to Statement of Cashflow, Tax Received	$1m

Where is the missing $45m?

SNOOPY

[dreamcatcher]

Few more days and divvie in the bank...........

[clearasmud]

Few more days and divvie in the bank...........

True.
Also last chance to Buy GNE cum divi

[Snoopy]

A reprise where this series of posts is coming from: I am trying to figure out why Contact's rate of dividend imputation is consistently higher than normalised profits would suggest is possible over the medium to long term. The quite below is from post 1806.

The following table has evolved from the period after the imputation credit balance was exhausted by the paying of a special dividend.

Dividend Payment Date	Net Amount	Dividend Imputation Rate	Gross Dividend Divisor	Imputed Dividend Tax Paid {A}	Sum of Half Year Income Tax Declared {B}	Tax paid less Tax Declared {A}-{B}
Various Dates Averaged		71.64%
Total 23-06-2016 Onwards				$289m	$226	$63m

This post is based on actual declared dividend payouts, and the tax paid implications from those payouts and company declared tax (not the derived tax from my 0.28x (EBITDAF - DA -I) calculation in post 1804, referred to in part 1). However, actual earnings are subject to various one off earnings blips (both up and down) from non core transactions that are not reflective of core business activity into the future.

How much tax is unaccounted for?

In the above quoted table, The (Sum of Half Year) 'Income Tax Declared' total is the 'Tax Expense' figure totalled from the respective full year and half reports in the respective 'Statements of Comprehensive Income' over five years. The 'Imputed Dividend Tax paid' is calculated from adding up the tax paid in the respective period dividend statements. Any positive difference between the two totals therefore must represent 'other tax' paid by Contact Energy, not recorded in the ''tax expense' income statement line entry. To pinpoint the 'missing tax' is the obvious way to make up the tax pay gap between the tax story told by the collective dividend payment statements and the tax story told by the 'tax expense' line of the 'Statements of Comprehensive Income'. This table quoted above shows this 'missing tax' from the tax expense line of the combined statements of Comprehensive Income over the period comes to a not insignificant $63m.

Scenario Basis Financial Year	Modelled Income Tax Paid	Actual Income Tax Paid
2016	$62m	($40m)
2017	$64m	$59m
2018	$51m	$41m
2019	$68m	$69m
2020	$49m	$46m
Total	$294m	$175m

The sub-totals from FY2016 onward (after the imputation credit balance was exhausted at EOFY2015), make the difference between modelled tax paid and the actual tax paid hard to explain. This could imply ...

<snip>

3/ Contact Energy have paid a lot of tax before it was due to inflate their imputation credit account before certain dividends were payable to shareholders. This would, IMO, be tantamount to an attempt to deceive shareholders about the real tax paying status of the company.

A conspiracy to mislead debunked

I am doing a slight retake on my explanation 3/ as quoted above. The tax that I am saying Contact 'paid in advance' was only 'paid in advance' from a shareholder income statement reporting perspective. In fact I now believe the tax was paid 'on time' in accordance with IRD rules. Nevertheless there was no word in the FY2016 report about what the future effects of doing this might be: the phenomenon I am terming 'Superimputed Dividends'. In recent years I have struggled to understand why the imputation rate paid on Contact Energy dividends was so much higher than I expected. It was only by piling through five years of retrospective dividend payments that I have been able to shed some light on what must have happened.

Why is the actual income tax paid so much less than what I modelled? I believe that is because that $175m total does not include the net $97m of tax paid from 'Significant Items' transactions as outlined in the quoted table below (Total Significant Items Tax = $4m + $100m+ $1m - $5m -$1m - $2m = $97m). Add that $97m back in and most of the difference between the 'Modelled Income Tax' and the 'Actual Income Tax Paid' is closed. I would not expect the totals to be exactly the same because actual tax payment bills for any five year period are spread across seven years (because of provisional tax and terminal tax billing requirements), not the five years shown in the table.

	FY2020	FY2019	FY2018	FY2017	FY2016
Reinstatement of tax on Depreciation of Powerhouses					$4m
Tax on Significant Items	$1m	($5m)	($1m)	($2m)	$100m

The very large elephant in the tax room is that $100m tax credit from FY2016. Now I am not a tax expert. But I do know that the tax return that is supplied to Inland Revenue and the tax treatment outlined to shareholders in the income statement of the annual report are not always the same. It could be that this $100m refund is tax that has already be paid but will not be refunded in one lump as just reading the income statement in the annual report implies. If instead the refund happens gradually over the normal depreciation life of those 'written off' Otahuhu generation assets, then Contact may have already paid more tax to the IRD than their reported earnings requires. And if Contact have paid more tax than their declared comprehensive tax position implies, that would mean they have a higher imputation credit balance on the books than shareholders might expect. That in turn might mean that dividends could be imputed to a higher rate than would otherwise be expected. Of course, any such tax balance differences between what is declared to the IRD and what is shown as the 'tax expense' in the income statement of the annual report will ultimately converge. But in the interim, the rate of dividend imputation on Contact shareholder dividend payments might have given shareholders a false picture of what dividend imputation rates are going to be possible looking forward.

The mechanics of paying 'phantom tax'

The story behind Contact Energy paying 'extra tax' is told in the panel I quote above. In summary I believe that Contact have used a timing difference between 'income tax that had to be paid to the IRD' and 'income tax on profit reported to shareholders' to generate extra imputation credits. From a shareholder perspective, these are 'phantom imputation credits' to boost the imputation rate on shareholder dividends.

Despite the name, these 'phantom imputation credits' are real. They are only seen as 'phantom' because they are 'seemingly materialising' (even though they already exist) by being drip fed through the declared income statements over several years. Eventually this drip feed will dry up. For the five financial years from FY2016 to FY2020 inclusive, I add up $97m of 'Significant Item' tax credits.

Total Significant Items Tax = $4m + $100m+ $1m - $5m -$1m - $2m = $97m

The bulk of these tax credits came about in FY2016, because of $204m of impairments net of tax relating to the closure of the Otahuhu Power Station, an assessment that the Taheke Geothermal field is unlikely to be developed in the foreseeable future (from a June 2016 perspective) and a write down in the value of inventory gas. I have calculated above that $63m of those tax credits have been used up (post 1806), which means that $97m - $63m = $34m are yet to materialise. That means there are probably two years worth of 'Superimputed dividends' for Contact Energy shareholders to come. What value of superimputation is appropriate? I am going with the average that I calculated in the first quoted post on this thread of 71.64%.

SNOOPY

[Snoopy]

Scenario Basis Financial Year	eps (A)	Scenario dps (B)
Total	225.6c (E)	369.0c (F)
Business Cycle Imputation Rate (E)/(F)		61.14%

.

The key figures in the first part of my 'Capitalised Dividend Valuation' for FY2020 I have quoted above. I now wish to change my modelled dividend imputation rate from 61.14% to 71.64% and see what difference that makes to my valuation. So how do I do that?

The first point to remember is that I am not making any changes to my assumption of the number in cents of each dividend I am modelling to be paid. The only change I am making is to the amount of imputation credits attached to each dividend. For Part 1 of my 'Capitalised Dividend Valuation' modelling I used the example of a total of $3.69 in dividends declared over 10 years (note all earnings values quoted are in 'earnings per share'). But full tax had only been paid on $2.256 of that dividend total. If tax had been paid on all of that dividend total, then the dividend imputation rate would have been:

$3.69 / $3.69 = 100%

But the actual rate of dividend imputation, based on $2.256 worth of normalised profits was only:

$2.256 / $3.69 = 61.14%

The question then is, what rate of normalised profits are necessary to produce an imputation rate of 71.64% if the dividend payment stays as it is? The algebraic way of writing that question is:

$ ? / $3.69 = 71.64%

And the answer is: 0.7164 x $3.69 = $2.644

So the difference in imputed earnings between the two different rates of imputation is: $2.644 - $2.256 = $0.388.

If I spread these extra underlying normalised tax paid earnings out over ten years (this is the equivalent of assuming straight line depreciation for any 'Phantom assets' over ten years) then the extra underlying earnings per year amount to: 38.8c / 10 = 3.9c

Now let's put this extra 3.9c per year of tax paid underlying earnings into the 'Capitalised Dividend' model and see what happens to Contact Energy's valuation

SNOOPY