Contact Energy - CEN Chart

[Snoopy]

The first option I think. Full imputation would have been 8.1666667 so 5.444444/8.16666667 is about 67%

21c/ (1-0.28) = 29.166667c (gross dividend fully imputed based based on a 28% tax rate)

	Gross Dividend	equals Imputation Credit	plus Net Dividend
Full Imputation	29.166667c	8.166667c	21c
Partial Imputation	26.444444c	5.444444c	21c

Question: To what rate is the above tabulated 'partially imputed dividend' imputed?

Answer 1/ 5.444444c / 8.166667c = 66.6666% or about 67%

Answer 2/ 5.444444c / (21c+5.444444c) = 20.59% about 21%

Answer 3/ If the maximum a dividend can be imputed to is 28%, and the actual rate the dividend was imputed to was 20.59% (see answer 2), then the rate at which the dividend has been imputed is:

20.59%/28% = 73.53% or about 74%

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I have a horrible feeling that all three answers are correct :-(.

The moral of this problem is - don't ask the question :-P. Or, if someone has the gall to ask the question, then don't read it. I think Troy was right!

SNOOPY

[Snoopy]

The percentage to which a dividend is imputed makes a great difference to the 'gross yield' on any share. The gentailers are a particular risk here, because their dividends are based on free cashflow, which includes earnings (fully imputed) as well as some depreciation allowance that will not need to be reinvested (not imputed). What does this picture look like over the last four years? I choose four years based on the statement that dividend payments will now be based on operating cashflows from the previous four years (NZX Release 15/02/2021).

I thought about what would be the best way to calculate the average imputation rate. Each dividend would have been individually considered by the board, and a decision made on what the appropriate imputation rate should be at each dividend payment time. So I have decided to just average the raw figures, exactly as they were presented to shareholders at the time. An alternative method, that I have chosen not to use, would be to take a weighted average imputation rate attached to each dividend in proportion to the size of that dividend.

For Contact Energy, the financial year runs from 1st July to 30th June.

Dividend Payment Date	Amount	Dividend Imputed to... {A}	Legal Imputed Maximum (B)	Dividend Imputation Rate (A)/(B)
18-09-2018	19cps	28.00%	28%	100.0%
09-04-2019	16cps	19.55%	28%	69.8%
17-09-2019	23cps	20.23%	28%	72.3%
07-04-2020	16cps	19.55%	28%	69.8%
15-09-2020	23cps	20.23%	28%	72.3%
30-03-2021	14cps	20.00%	28%	71.4%
15-09-2021	21cps	21.00%	28%	75.0%
30-03-2022	14cps	22.00%	28%	78.6%
Average				76.15%

Readers may notice that the imputation rate has picked up a bit over the last couple of years. However, this is logical when viewed in the big picture of a largely static profit and cashflow market (new capital raising for the new Tauhara geothermal station excepted) combined with a small reduction in the dividend. The more of the dividend that is paid from actual profits, the higher the dividend imputation rate. If you reduce your dividend in a flat earnings environment, then you are reducing that part of the dividend that does not come from profits. That means overall, the imputation rate of any such dividend paid is likely to go up.

Contact's stated new policy of reducing their dividend to 80-100% of operating free cashflow means the higher imputation rates of FY2022 are more likely to continue into the future.

The percentage to which a dividend is imputed makes a great difference to the 'gross yield' on any share. The gentailers are a particular risk here, because their dividends are based on free cashflow, which includes earnings (fully imputed) as well as some depreciation allowance that will not need to be reinvested (plus and amount not imputed). What does this picture look like over the last four years? I choose four years based on the statement that Contact dividend payments will now be based on operating cashflows from the previous four years (NZX Release 15/02/2021).

I think I have made a mistake in ancestor posts, where my previous quest to determine the 'dividend imputation rate' and use that number. Instead my objective should have been to answer the question:

"If a dividend is delivered with less than full imputation, then what divisor do I need to divide into that dividend to produce the gross dividend figure?"

So I think it is best if I move away from the concept of 'rate of dividend imputation', because that concept as you can see in my post 2251, can be ambiguous.

The last dividend in my table below has not been paid yet. But note B3 from AR2022 tells us it will be 21c '90% imputed'. If I use Doug's definition of imputation (post 2251) then this implies imputation credits per 21c share dividend of:

0.9 x 8.166667c = 7.35c

So the gross dividend becomes: 21c+7.35c = 28.35c. To get that figure from 21c requires a divisor of:

21/28.35= 0.7407

I thought about what would be the best way to calculate an 'average divisor rate' across four years. Each dividend would have been individually considered by the board, and a decision made on what the appropriate imputation rate should be at each dividend payment time. So I have decided to just average the raw figures, exactly as they were presented to shareholders at the time. An alternative method, that I have chosen not to use, would be to take a weighted average imputation rate attached to each dividend in proportion to the size of that dividend.

For Contact Energy, the financial year runs from 1st July to 30th June.

Dividend Payment Date	Amount	Dividend Imputed to... {A}	Legal Imputed Maximum (B)	Net Dividend Divisor (1-A)
09-04-2019	16cps	19.55%	28%	0.8045
17-09-2019	23cps	20.23%	28%	0.7977
07-04-2020	16cps	19.55%	28%	0.8045
15-09-2020	23cps	20.23%	28%	0.7977
30-03-2021	14cps	20.00%	28%	0.8000
15-09-2021	21cps	21.00%	28%	0.7900
30-03-2022	14cps	22.00%	28%	0.7800
27-09-2022	21cps	25.20%	28%	0.7407
Average				0.7894

Readers may notice that the imputation rate has picked up a bit over the last couple of years. However, this is logical when viewed in the big picture of a largely static profit and cashflow market (new capital raising for the new Tauhara geothermal station excepted) combined with a small reduction in the dividend. The more of the dividend that is paid from actual profits, the higher the dividend imputation rate. If you reduce your dividend in a flat earnings environment, then you are reducing that part of the dividend that does not come from profits. That means overall, the imputation rate of any such dividend paid is likely to go up.

Contact's stated new policy of reducing their dividend to 80-100% of operating free cashflow means the higher imputation rates of FY2022 are more likely to continue into the future.

SNOOPY

[Snoopy]

Contact with their '80%-100% of Free Operating Cashflow' looks, in practice, to be paying dividends towards the bottom of their indicated range. I believe this is because the policy was based on 'averaged hydro-logical conditions'. If the inflows were above average (which they were in FY2019), then the dividend was not increased. My modelled future dividend scenario is that dividends will be capped at 37cps (This reflects the period after Tauhara has been commissioned remember). Over FY2022 dividends paid during that period amounted to 35cps.

I continue to use my model based on just the last four years of operations.

1/ The 'Scenario 'Dividend Per Share' and 'Scenario Earnings Per Share' columns (from my post 2198) represent a prediction of an ongoing dividend of 80% of free cash flow being paid into the foreseeable future, but now capped at 37cps.

The FY2021 actual dividend payment, under the same policy of paying out 80-100% of free cashflow, was 35cps. This is somewhat less than my four forecast scenarios where dividends are 37cps. But these scenarios reflect a future where Tauhara is operational which should provide an incremental boost to Contact's profitability. I do not consider the modelled dividend payout to be unrepresentatively high, once Tauhara is up and running.


2/ The (A) - (B) difference column, if negative, represents the amount of the projected dividend not covered by imputation credits. This is important, because a dividend paid without imputation credits is -in accounting terms-, equivalent to giving shareholders their own capital back (equal to the amount of the unimputed dividend) complete with a tax bill. This is generally bad for investors. It is necessary to make a negative adjustment to account for any expected tax to be paid on the unimputed dividend component (Column (D).
3/ The capital component of the dividend (Column C) is the portion of shareholder equity being returned to shareholders. This will need to be removed from the dividend return calculation. Because to pay it is to return to shareholders money on the balance sheet that they already have, so it isn't a shareholder benefit.
4/ The unimputed component tax bill (Column D), represents the income tax charged on share capital that is expected to be paid by the shareholder. A 28% tax bill from the value calculated in Column C is assumed. Note that if the (A)-(B) difference were to be positive then there would be no extra tax bill. That's because in such a year, the dividend would be 'fully imputed'.
5/ The final 'Difference Column' represents the 'effective' net dividend per share, adjusted for any extra tax obligation from paying tax on unimputed distributions.

Scenario Basis Financial Year	eps (A)	Scenario dps (B)	Difference (A)-(B)	Divie Capital Component (C)	Unimputed Tax Bill (D)	Difference (B)-(C)-(D)
2018	21.8c	37.0c	-15.2c	15.2c	4.3c	17.5c
2019	27.3c	37.0c	-9.7c	9.7c	2.7c	24.6c
2020	21.3c	37.0c	-15.7c	15.7c	4.4c	16.9c
2021	28.3c	37.0c	-8.7c	8.7c	2.4c	25.9c
Total	98.7c (E)	148.0c (F)				84.9c
Business Cycle Imputation Rate (E)/(F)		66.69%

.

The expected average dividend per year, net of tax is therefore: 84.9 / 4 = 21.2cps (net)

Using a tax rate of 28c this is equivalent to a gross income of: 21.2cps /(1-0.28) = 29.4cps

Now we come to a critical point in this analysis - the choosing of an 'indicative interest rate' that allows us to value Contact on the basis of being an ongoing income stream.

Contact with their '80%-100% of Free Operating Cashflow' looks, in practice, to be paying dividends towards the bottom of their indicated range. I believe this is because the policy was based on 'averaged hydro-logical conditions'. If the inflows were above average (which they were in FY2019), then the dividend was not increased. My modelled future dividend scenario is that dividends will be capped at 37cps (This reflects the period after Tauhara has been commissioned remember). Over FY2022 dividends paid during that period amounted to 35cps.

I continue to use my model based on just the last four years of operations.

1/ The 'Scenario 'Dividend Per Share' and 'Scenario Earnings Per Share' columns (from my post 2245) represent a prediction of an ongoing dividend of 80% of free cash flow being paid into the foreseeable future, but now capped at 37cps.

The FY2021 and FY2022 actual dividend payments, under the same policy of paying out 80-100% of free cashflow, was 35cps. This is somewhat less than my four forecast scenarios where dividends are 37cps. But these scenarios reflect a future where Tauhara is operational which should provide an incremental boost to Contact's profitability. I do not consider the modelled dividend payout to be unrepresentatively high, once Tauhara is up and running.

2/ The (A) - (B) difference column, if negative, represents the amount of the projected dividend not covered by imputation credits. This is important, because a dividend paid without imputation credits is -in accounting terms-, equivalent to giving shareholders their own capital back (equal to the amount of the unimputed dividend) complete with a tax bill. This is generally bad for investors. It is necessary to make a negative adjustment to account for any expected tax to be paid on the unimputed dividend component (Column (D).
3/ The capital component of the dividend (Column C) is the portion of shareholder equity being returned to shareholders. This will need to be removed from the dividend return calculation. Because to pay it is to return to shareholders money on the balance sheet that they already have, so it isn't a shareholder benefit.
4/ The unimputed component tax bill (Column D), represents the income tax charged on share capital that is expected to be paid by the shareholder. A 28% tax bill from the value calculated in Column C is assumed. Note that if the (A)-(B) difference were to be positive then there would be no extra tax bill. That's because in such a year, the dividend would be 'fully imputed'.
5/ The final 'Difference Column' represents the 'effective' net dividend per share, adjusted for any extra tax obligation from paying tax on unimputed distributions.

Scenario Basis Financial Year	eps (A)	Scenario dps (B)	Difference (A)-(B)	Divie Capital Component (C)	Unimputed Tax Bill (D)	Difference (B)-(C)-(D)
2019	27.3c	37.0c	-9.7c	9.7c	2.7c	24.6c
2020	21.3c	37.0c	-15.7c	15.7c	4.4c	16.9c
2021	28.2c	37.0c	-8.8c	8.8c	2.5c	25.7c
2022	26.9c	37.0c	-10.1c	10.1c	2.8c	24.1c
Total	103.7c (E)	148.0c (F)				91.3c
Business Cycle Imputation Rate (E)/(F)		70.07%

.

The expected average dividend per year, net of tax is therefore: 91.3 / 4 = 22.8cps (net)

Using a tax rate of 28c this is equivalent to a gross income of: 22.8cps /(1-0.28) = 31.7cps

Now we come to a critical point in this analysis - the choosing of an 'indicative interest rate' that allows us to value Contact on the basis of being an ongoing income stream.

SNOOPY

[Snoopy]

The expected average dividend per year, net of tax is therefore: 91.3 / 4 = 22.8cps (net)

Using a tax rate of 28c this is equivalent to a gross income of: 22.8cps /(1-0.28) = 31.7cps

Now we come to a critical point in this analysis - the choosing of an 'indicative interest rate' that allows us to value Contact on the basis of being an ongoing income stream.

If we assume that a business cycle investment 'gross return' of 5.0% is required, then this equates to a CEN share price of no more than:

31.7c /0.05 = $6.34

So $6.34 is therefore 'fair value' on a 'whole of business cycle' dividend basis.

We need to discount from this $6.34 - by a factor - the earnings from the as yet uncompleted Tauhara geothermal power station. We need to discount these earnings back using an appropriate 'time value of money' factor. We need to remember that this discount only applies to the incremental value of the earnings from the new Tauhara project, not all of Contact's earnings. Tauhara is now expected to be operational in the second half of FY?2023 (08-02-2022 Press Release). This means it will be fully operational over FY2024. Taking an FY2022 perspective, FY2024 is two years into the future. Thus the discounting factor that I calculated back in post 2245 over 2 years -to be 0.9070- is appropriate.

EBITDAF-DA-I-T (Normalised NPAT) for the four years under consideration for use in dividend forecasting -excluding Tuahara- , (again from post 2245) were $175m, $127m, $183m and $172m. I make the four year average $164m. Tauhara is a geothermal station, and so will likely operate as base load generation, with energy output not varying much over the years. This means that over the business cycle, with an expected net profit from Tauhara of $45m (refer post 2245), Tauhara should lift Contact Energy profits by:

$45m/$164m= 27.4%

Or looked at another way, from FY2024, Tauhara will be generating electricity supplying $45m/($164m + $45m) = 21.5% of Contact Energy profits (on average), compared to 78.5% of the .profits emerging from the rest of the Contact generation portfolio.

This means I need to adjust my fair value income yield valuation for Contact Energy as follows.

(0.785)($6.34) + (0.215)($6.34)(0.9070) = $6.21

The above valuation is effectively a 'no growth' valuation, that does not take into account any rises in value of the existing underlying power generation assets above book value. Increases in the value of power generation assets above book vale are a measure of the incremental discounted value of future cashflows, which feed from higher profits from existing generation assets. These higher profits are caused by legacy generation with low operating costs selling power into an ever higher average power price market. Contact Energy chooses not to increase the value of existing generation assets on the books annually (but competitor Mercury Energy does). However, I believe that to truly reflect the growth value of the Contact Energy generation portfolio, it is necessary to do this. So 'generation asset revaluation' is the next additive part of this Contact Energy share valuation exercise.

SNOOPY

P.S.

Tauhara Discount Factor for Future Earnings (Potential Valuation Tool)

This incremental increase in NPAT should perhaps be discounted back because it will not occur for two years time, at the point where Tauhara comes on line. For future discounting of profits, I use a 5.0% discount rate, which equates to the long term Gross Yield I am prepared to accept. Looking at the estimated incremental Tauhara profit of $45m.

1/(1.05)^2 = 0.9070

$45m x 0.9070 = $41m

[Snoopy]

My fair value income yield valuation for Contact Energy as follows.

(0.785)($6.34) + (0.215)($6.34)(0.9070) = $6.21

The above valuation is effectively a 'no growth' valuation, that does not take into account any rises in value of the existing underlying power generation assets above book value. Increases in the value of power generation assets above book vale are a measure of the incremental discounted value of future cashflows, which feed from higher profits from existing generation assets. These higher profits are caused by legacy generation with low operating costs selling power into an ever higher average power price market. Contact Energy chooses not to increase the value of existing generation assets on the books annually (but competitor Mercury Energy does). However, I believe that to truly reflect the growth value of the Contact Energy generation portfolio, it is necessary to do this. So 'generation asset revaluation' is the next additive part of this Contact Energy share valuation exercise.

Contact Energy generation assets that have a significant unbooked premium on their book value are the hydro assets at Clyde and Roxburgh. We can estimate the quantum of this from similar increases in hydro station value that were booked by competitor Mercury Energy (see post 1878). The rising value of future cashflows, that increase the relative worth of long lived legacy power generation assets is an additional 'return' - for which I have previously coined the term 'thin air capital'. That sounds ethereal, and is, to the extent that this 'capital' appears solely on the expectation of power prices rising. However, although the short term power prices at the wholesale level go up and down, long term power prices go up and up. So in practice I have never seen any of the Mercury Energy declared new 'thin air capital' on their hydro generation assets ever vanish, even if theoretically it could (This is why I like the name 'thin air capital', because it carries a juxtaposed connotation of 'fragile permanence').

The 'thin air' capital growth for Mercury hydro assets is shown below. Both Mercury and Contact operate in the same electricity market. That is why I consider the thin air capital accumulated by Mercury as an indicative factor to use for the thin air capital accumulated (but not recognised) by Contact management over that same period. Information in the table below is derived from posts 1450 and 1456 in the Mercury thread.

Mercury Energy	Reval. Hydro & Thermal Assets ($m)	Reval. Geothermal & Other Generation Assets ($m)	Reval. Wind Generation Assets ($m)	Total Revalued Generation Assets
2015	355	142	N.A.	497
2016	82	55	N.A.	137
2017	0	52	N.A.	52
2018	0	55	N.A.	55
2019	151	99	N.A.	250
2020	253	43	N.A.	296
2021	550	388	N.A.	938
2022	139	1	153	293
Total	1,530

That $1,530m of thin air incremental capital raised was based on a total hydro generating capacity of 1059MW (Post 1450, Mercury Thread). The total Contact Energy hydro electric generation capacity is 784MW (my post 1514). So I can determine my 'best guess' at the thin air capital accumulated by Contact Energy subsequent to the FY2014 balance date by ratio:

$1,530m x 784MW/1059MW = $1,133m

I have decided to change my asset increment valuation approach from previous years. Revalued assets, according to accounting rules attract an associated tax liability, on a deferred basis. Contact Energy are not revaluing their assets as is their policy. But if they did, they would incur such a deferred tax liability amounting to 28% of the revaluation amount, (which may never be crystallised). Nevertheless I am going to use the revaluation amount net of any deferred tax to be consistent with the accounts of competitor Mercury Energy, which does revalue assets and does follow the revaluation and deferred tax rules.

$1,133m (Asset Revaluation) = $816m (Net Asset Revaluation) + $317m (Deferred tax liability)

New Capital projects are funded by a combination of debt and equity. If we take a 54% equity ratio going forwards as 'acceptable' (see post 2205, 54% being a typical value pre the March 2021 capital raising for Tauhara), then this $816m of new 'thin air' equity could in theory fund capital projects to the tune of:

$816m / 0.54 = $1,511m

Take the project capital needed to complete Tauhara out of that total, and new incremental project capital is reduced to:

$1,511m - $818m = $693m.

Now 693/818= 0.847. And 168MW x 0.847 = 142MW

Theoretically, add in a new companion bond program, and it means I can see equity capital for another Tauhara sized field geothermal station (actually a geothermal station 84.7% the size) as being available right now.

A new 142MW power station would lift operational generating capacity by

(142MW x 0.94) / (403MW + 527MW) = +14.4%

(refer post 2206 for method)

This raises my 'fair value' of Contact Energy, based on my steady state income valuation, by 14.4%

$6.21 x 1.144 = $7.10

CEN closed on the market on Friday at $7.85, which makes it 11% overvalued by my way of looking at things.

SNOOPY

discl: holder

[Snoopy]

FY2021	Contact Energy	Mercury Energy
No. Shares	776.1m	1,400m
Share Price (12-08-2022)	$7.71	$6.50
Normalised PE	32.7	64.4
Normalised NPAT Margin	8.8%	8.4%
Normalised NPAT eps	23.6c	10.1c
Gross dps	44.3c	25.3c
Gross Dividend Yield	5.75%	3.89%
ROE (Assets at Cost)	10.6%	6.6%
Bank Debt	$856m	$1,491m
Min. Debt Repayment Time	4.68 years	10.5 years
Snoopy's Fair Share Price Valuation (3)	$6.98	$5.76
Current Market Premium or Discount to Fair Value	+10.5%	+12.8%

Notes:

1/ Both CEN valuation and MCY valuation contain adjustment factors to include the value of 'thin air capital' accumulated. For Mercury this is +23.0%. For Contact Energy the adjustment factor is +22.5% It is no longer Contact policy to revalue their assets annually. Hence Contact's balance sheet does not contain 'thin air capital', but Mercury's balance sheet does.

2/ The FY2021 financial statements of both companies were compiled on the assumption that the Tiwai Point Aluminium Smelter is to remain as a going concern.

3/ The working for 'Snoopy's fair price valuations may be found on this thread in posts 2199 and 2201 (Contact Energy) and on the Mercury Energy Thread (posts and 1428, 1442 and 1451). The method I used was capitalising the dividend averaged over recent years (in the case of Contact revised according to present dividend policy), and added a 'fudge factor' representing future forecast dividends from further power generation facilities planned but not yet built.

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My snoopshot view shows a present day 'close value tussle' between 'Contact Energy' and 'Mercury Energy', notwithstanding the stratospheric PE ratios now commanded by both companies. My modelling is based on both companies building substantial new power stations (Tauhara Geothermal for Contact, Turitea Wind for Mercury), with those new incremental power station earnings already priced in to today's share market price for both. Once these developments come on stream, those historic stratospheric market PEs (which are based on historic earnings) for MCY and CEN should reduce.

Mercury Energy has in August 2021, post the FY2021 reporting period, unwound a strategic stake in 'Tilt Renewables', a listed entity that developed and operated wind farms in New Zealand and Australia. 'Tilt Renewables' has been subject to a joint takeover offer from 'Mercury Energy' and Australian based 'Powering Australian Renewables' (PowAR). The result being that Tilt was 'carved up', with Mercury acquiring the NZ based windfarm portfolio (mainly Manawatu based previously owned by Trustpower) and PowAR the Australian based windfarms.

'Net Profit margin' has tightened up between the two protagonists from the previous comparative year. Mercury noted over FY2021 particular 'headwinds that included challenging generation conditions and elevated spot prices' (AR2021 p8). The debt risk indicator of 'MDRT' now favours Contact Energy, which did a significant capital raising during the FY2021 year.

The present day Contact Energy and Mercury market price premiums are not sufficient to make me sell up. There are sufficient growth plans tabled, beyond Turitea and Tauhara, to keep each business growing. The decarbonisation program at Contact as they continue to roll out geothermal developments, and soon windfarms, combined with the winding down of their remaining gas burning assets, should lower the cost base of the power being generated. Mercury is in the middle of a major restructure with the incorporation of new central North Island both organic (Turitea) and acquired (Tilt) wind farm assets. With their strong central North Island hydro-generation presence, this combination should prove an energy supply management game changer.

I will plan to update my comparative table as both Contact and Mercury produce their full year results over the next month or so. In the meantime I will be 'sitting tight' on both my Contact Energy and Mercury Energy shareholdings.

FY2022	Contact Energy	Mercury Energy
No. Shares	780.6m	1,400m
Share Price (22-08-2022)	$7.85	$6.35
Normalised PE	35.7	54.7
Normalised NPAT Margin	9.3%	9.1%
Normalised NPAT eps	22.0c	11.6c
Gross dps	44.3c	25.3c
Gross Dividend Yield	5.64%	3.89%
ROE (Assets at Cost)	10.1%	5.7%
Bank Debt	$1,099m	$2,831m
Min. Debt Repayment Time	6.39 years	12.0 years
Snoopy's Fair Share Price Valuation (3)	$7.10	$6.01
Current Market Premium or Discount to Fair Value	+10.6%	+5.7%

Notes:

1/ Both CEN valuation and MCY valuation contain 'adjustment factors' to include the value of 'thin air capital' accumulated. For Mercury this is +26.8%. For Contact Energy the 'adjustment factor' is +14.4% It is no longer Contact policy to revalue their assets annually. Hence Contact's balance sheet does not contain 'thin air capital', but Mercury's balance sheet does. The Contact Energy 'Thin Air Capital' used in this comparison is my own construct, based on what would have happened if Contact had followed Mercury's 'Thin Air capital' policy

2/ The FY2022 financial statements of both companies were compiled on the assumption that the Tiwai Point Aluminium Smelter is to remain as a going concern.

3/ The working for 'Snoopy's fair price valuations may be found on this thread in posts 2253, 2254 and 2255 (Contact Energy) and on the Mercury Energy Thread (posts and 1462 and 1463). The method I used was capitalising the dividend averaged over recent years (in the case of Contact revised according to present dividend policy), and added an 'adjustment factor' representing future forecast dividends from further power generation facilities planned but not yet built.

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My financial modelling is based on both companies having already completed building substantial new power stations (Tauhara Geothermal for Contact, Turitea North Wind for Mercury), with those new incremental power station earnings already priced in to today's share market price for both. The earnings included from Tauhara are forecasts. The earnings included from Turitea North are real, but inconsistent with full year annual production, because this wind-farm was only commissioned during FY2022 (fully commissioned December 2021).

Mercury Energy in August 2021, early in the FY2022 reporting period, unwound a strategic stake in 'Tilt Renewables', a listed entity that developed and operated wind farms in New Zealand and Australia. The net result was that Tilt was 'carved up', with Mercury acquiring the NZ based windfarm portfolio (mainly Manawatu based previously owned by Trustpower). Wind generation from this acquisition was slightly below expectations with less windy weather than forecast.

Very late in the financial year (02-05-2022), Mercury acquired the retail customer base of Trustpower for $467m. Consequently the incremental debt of $187m incurred in making this purchase appeared on the balance sheet immediately. But the earnings stream from this purchase will not fully come on song until FY2023 (the Trustpower retail business contributed just $12m in revenue over FY2022). This points to a reduction in the historic stratospheric market PER for Mercury in particular over FY2023.

'Net Profit margin' has tightened up between the two protagonists from the previous comparative year. But Mercury noted over FY2022 a second year low inflows into the Waikato catchment (just the 30th percentile on average). Heavy rainfall in June 2022 restored the Lake Taupō level to well above the historic average and 70% full, positioning hydro generation well for the start of FY2023. Contact had less 'operational excuses ' to report, this years result being achieved "with highly variable hydrology" (AR2022 p9) being the main signal of an atypical year. With more normal hydro-logical conditions, it looks like Mercury will see more incremental improvement than Contact.

The debt risk indicator of 'MDRT' favours Contact Energy, which did a significant capital raising during the FY2021 year.

The significant difference in ROE is because Mercury, has dramatically increased their generation capacity by purchasing assets at 'current market prices' (the Tilt Windfarms). It is not a sign of asset management incompetence.

The present day Contact Energy and Mercury market price premiums are not sufficient to make me sell up. There are sufficient growth plans tabled, beyond Turitea and Tauhara, to keep each business growing. The decarbonisation program at Contact as they continue to roll out geothermal developments, and soon windfarms, combined with the winding down of their remaining gas burning assets, should lower the cost base of the power being generated. Mercury is in the middle of a major restructure with the incorporation of new central North Island both organic (Turitea) and acquired (Tilt) wind farm assets. With their strong central North Island hydro-generation presence, this combination should prove an energy supply management game changer. I see a bright future for both companies. But in my ever present search for value, I would wait for some kind of cyclical share price dip before topping up my existing shareholdings in either.

SNOOPY

discl: hold MCY and CEN

[Snoopy]

I like to do these head to head comparisons using a 30th September comparison date. This for convenience (corresponding in my records to six months into the tax year) and also because it gives the market a month or so to 'digest' an annual result announced in August, normally related to a reporting period ended 30th June. In actuality I delayed my September 2021 report to early August 2022 making it way out of date. Consequently I included some updated information to make it more relevant until the FY2022 edition of my head to head report was ready.

Now I want to go back to 30-09-2021 and publish my comparison as if it had been written then. This will provide a better comparative marker with the FY2022 head to head table.

FY2021 (Retrospective)	Contact Energy	Mercury Energy
No. Shares	776.1m	1,400m
Share Price (30-09-2021)	$8.45	$6.50
Normalised PE	35.8	64.4
Normalised NPAT Margin	8.8%	8.4%
Normalised NPAT eps	23.6c	10.1c
Gross dps	46.4c	22.5c
Gross Dividend Yield	5.49%	3.46%
ROE (Assets at Cost)	10.6%	6.6%
Bank Debt	$856m	$1,491m
Min. Debt Repayment Time	4.68 years	10.5 years
Snoopy's Fair Share Price Valuation (3)	$6.98	$5.76
Current Market Premium or Discount to Fair Value	+21.1%	+12.8%

Notes:

1/ Both CEN valuation and MCY valuation contain adjustment factors to include the value of 'thin air capital' accumulated. For Mercury this is +23.0%. For Contact Energy the adjustment factor is +22.5% It is no longer Contact policy to revalue their assets annually. Hence Contact's balance sheet does not contain 'thin air capital', but Mercury's balance sheet does.

2/ The FY2021 financial statements of both companies were compiled on the assumption that the Tiwai Point Aluminium Smelter is to remain as a going concern.

3/ The working for 'Snoopy's fair price valuations' may be found on this thread in posts 2199, 2201 and 2202 (Contact Energy) and on the Mercury Energy Thread (posts and 1428, 1442 and 1451). The method I used was capitalising the dividend averaged over recent years (in the case of Contact revised according to present dividend policy), and adding an 'adjustment factor' representing future forecast dividends from further power generation facilities planned but not yet built.

------------------------------

My snoopshot view shows a clear value benefit in holding 'Mercury Energy' over 'Contact Energy'. Since I am 'posting from the future', as far as this valuation study goes, we can see that the MCY share price held steady over the year while the CEN share price declined by 10%. I will take that as some vindication of my valuation methodology. The high PE ratios now commanded by both companies is both a positive cashflow issue (dividends are a lot higher than profits), and representative of the fact that both companies are in a 'development phase'. .

My modelling is based on both companies building substantial new power stations (Tauhara Geothermal for Contact, Turitea Wind for Mercury), with those new incremental power station earnings already priced in to today's share market price for both. Once these developments come on stream, those historic stratospheric market PEs (which are based on historic earnings) for MCY and CEN should reduce.

Mercury Energy has in August 2021, post the FY2021 reporting period, unwound a strategic stake in 'Tilt Renewables', a listed entity that developed and operated wind farms in New Zealand and Australia. 'Tilt Renewables' has been subject to a joint takeover offer from 'Mercury Energy' and Australian based 'Powering Australian Renewables' (PowAR). The result being that Tilt was 'carved up', with Mercury acquiring the NZ based windfarm portfolio (mainly Manawatu based previously owned by Trustpower), while PowAR acquired the Australian based windfarms.

'Net Profit margin' has tightened up between the two protagonists from the previous comparative year. Mercury noted over FY2021 particular 'headwinds that included challenging generation conditions and elevated spot prices' (AR2021 p8). The debt risk indicator of 'MDRT' now favours Contact Energy, which did a significant capital raising during the FY2021 year.

The historic Contact Energy and Mercury market price premiums were not sufficient to make me sell up. There are sufficient growth plans tabled, beyond Turitea (Mercury) and Tauhara (Contact), to keep each business growing. The decarbonisation program at Contact as they continue to roll out geothermal developments, and soon windfarms, combined with the winding down of their remaining gas burning assets, should lower the cost base of the power being generated. Mercury is in the middle of a major restructure with the incorporation of new central North Island both organic (Turitea) and acquired (Tilt) wind farm assets. With their complimentary strong central North Island hydro-generation presence, the Wind / 'Hydro battery' combination should prove an energy supply management winner.

SNOOPY

[Jantar]

….

But where did the water from Lake Roxburgh come from? It came upstream from the Clyde dam. And it would only benefit Contact to release extra water from the Clyde dam for Lake Roxburgh (and hence Onslow) when power prices are high.

b/ If the Clyde dam was forced to release water to fill Lake Roxburgh when prices were low (Prof Beardsly's scenario), then doesn't that mean that water will be running through the Clyde dam when prices are low? That surely is not what Contact Energy wants?.....
SNOOPY

Both Clyde and Roxburgh are run-of river stations and both have minimum flow requirements. For Clyde it is 120 cumecs from 1 hr after sunset to 1 hr before sunrise, measured at the Clyde Golf Course which is about 1 1/4 hours flow time down stream from Clyde. For Roxburgh it is 250 cumecs measured immediately below Roxburgh power station. Thus Contact has to release water from Clyde to supply Roxburgh whether prices are high or low, and Clyde cannot hold water back over the 250 cumecs needed at Roxburgh for more than a few hours or it will exceed the maximum operating level of Clyde dam. Total storage in Clyde is measured in hours, not days, and Roxburgh only has 6 hours storage. Also to put the flows in perspective, a single machine at Roxburgh uses 100 cumecs at full load. Depending on whether Onslow uses the 120 MW units as suggested by Majeed, or the 250 MW units suggested by MBIE, the flow of an Onslow unit on full load would be either 17 or 40 cumecs. So a very small flow to or from Onslow compared to Roxburgh's flow.

If the Onslow intake is above the Roxburgh dam, Contact loses a small amount of water when flows re high and prices are low, but gets it all back (with no losses) when flows are low and prices are high. If the intake is below Roxburgh, then a new dam would need to built across the Clutha River in order to give a lower reservoir and sufficient pumping head. This in turn would be detrimental to Contact as it would raise the Roxburgh tail water level and reduce the operating head, and efficiency, of the Roxburgh turbines.

When the Clutha River flows are low enough that water is being released from Hawea to meet those requirements power prices are high enough that Onslow would be generating, and thus assisting Roxburgh to meet its minimum flow and reducing the amount of water that has to be wasted from Hawea. This allows the Hawea water to used more efficiently at both Clyde and Roxburgh.

Pumping would only occur when prices are low, or when there is more water in the Clutha river than is needed for minimum flows in the Clutha.

[Jantar]

Government policy is that nobody owns water. Therefore water can be taken to fill Lake Onslow by whoever, whenever. If Contact wanted an unwinable battle, they could hold water at Clyde, and when Lake Roxborough hit minimum level, Lake Onslow could be filled no further. Then legislation would be enacted to force the release of water

But it won't come to that. The generators know they have 10 years of massive profits left. Then it will be a different market, different CEO, different BOD etc and probably a different wholesale pricing mechanism

The minimum flow from Roxburgh requires that water be released from Clyde. Similarly, water cannot be held back at Clyde as Clyde's storage is measured in hours, not days.

[Jantar]

…..
a/ The power price fluctuates with time AND SO
b/ It becomes possible to take power from a generation site- where there is no alternative use of that power at that time (i.e. it has a low instantaneous 'market value') - so that you can use what would otherwise be 'wasted energy' to 'pump water up hill'.

The problem I see with using hydro-electricity to do this is that there is always an alternative use. Just keep the water behind the dam until it is needed! …...
SNOOPY

Clyde dam has 22 hours storage at average inflows and minimum outflows, so cannot simply hold water behind the dam until it is needed.