Contact Energy - CEN Chart

[Snoopy]

Looking at valuation of assets was interesting - MRP assets seem to be re-valued annually and, provided the value increase outstrips depreciation, the accumulated depreciation appears to get written back to zero. CEN, on the other hand, seems to be working off 2004 book values for assets held at that time and at cost thereafter for additions and improvements. If I have read it correctly, it therefore seems that the values placed on CEN assets are likely to be more conservative.

According to my records Lizard, CEN last revalued their assets for the FY2007 annual report and the amount of that revaluation was $401.09m. Before that there was a revaluation of $550.3m that came into the books for the FY2004 annual report. Contact have (had?) a policy of revaluing their assets every three years. But there was no revaluation in FY2010. I don't know if this is because the assets were not worth revaluing, or if the policy changed. If the revaluation policy is still in force, CEN shareholders can expect the assets to be revalued in time for the FY 2013 annual report.

SNOOPY

PS If your evaluation of the MRP assets valuation policy is accurate, it does sound like pushing the envelope. All that remains to be done is to produce the next MRP annual report with a red cover, wave it outside parliament and Russell Norman and his Green/Labour friends will be sharpening their horns.

[Lizard]

I think you will find the change on page 60 of the 2010 annual report, where it explains that the 2007 valuation gains were reversed in a move back to cost basis:

Contact has elected to make a voluntary change in accounting policy in relation to the measurement basis for generation plant and equipment and move to a cost basis as it is reliable and more relevant. The change in accounting policy has been applied retrospectively to 1 October 2004, the date of Contact’s transition to NZ IFRS and the date of acquisition of 51.4 percent of the shares in Contact by Origin. Fair value at 1 October 2004 is considered deemed historical cost owing to the impracticability of determining actual cost back to the original asset purchase date. As a result of the change, the revaluation reserve at 1 October 2004 ($1,547.6 million) has been transferred to retained earnings. In addition, the revaluation in 2007($401.1 million) and the consequential deferred tax ($120.3 million) have been reversed.

[Lizard]

Still feeling my way as far as how much to read into various industry stats and comparisons, but from what I could find, CEN had 23% of NZ electricity generation in the 6 months to March and MRP had 17%. MRP had $5.0 bn on balance sheet of "property, plant and equipment" and CEN had $5.1 bn. Which appears to me, at least on the surface, to add weight to the view that CEN's assets are undervalued in comparison to MRP (or MRP's over-valued vs CEN).

[Snoopy]

I think you will find the change on page 60 of the 2010 annual report, where it explains that the 2007 valuation gains were reversed in a move back to cost basis:

Quite right Lizard, regarding basing current power station valuations on 2004 book values, as reassessed in the 2010 annual report. That will teach me not to read the foot notes! That makes sense from the point of view of Origin taking their controlling stake at that time. But it is odd in the sense that the change to historic valuation was made because there was little likelihood of power stations being readily tradable entities. Yet IIRC it was almost exactly about that time that the government did quite a bit of cross trading of SOE power assets in preparation for the upcoming Mighty River, Meridian and Genesis floats!

I have held CEN since the float and had more or less consigned it to the bottom drawer. It was performing well if not spectacularly. CEN was doing its job in offsetting my own power bills via dividends received. But with the National lead government power floats and stuttering sharemarket performance, it is time for me to pay some more attention to CEN.

SNOOPY

[Snoopy]

Still feeling my way as far as how much to read into various industry stats and comparisons, but from what I could find, CEN had 23% of NZ electricity generation in the 6 months to March and MRP had 17%. MRP had $5.0 bn on balance sheet of "property, plant and equipment" and CEN had $5.1 bn. Which appears to me, at least on the surface, to add weight to the view that CEN's assets are undervalued in comparison to MRP (or MRP's over-valued vs CEN).

Good point made on generating asset value to market share making Contact Energy look good relative to MRP.

More points of favour for Contact: CEN are better diversified geographically in terms of generation assets. Not that this is necessarily a 'problem' as the real trick is matching the generation base with the customer base. Having generation assets all over the country decreases the downstream customer risk of having a bad year in hydro generation though.

Both CEN and MRP have their hydro base on one big river system. But CEN has more inflows from snowmelt. For that reason I see CEN as potentially a more reliable hydro generator than MRP. This is leaving aside the earthquake stability of the Clyde dam.

The main negative I see with CEN is that their large gas fired station just south of Auckland, the largest market, carries with it some fuel price risk. Contact themselves have chosen to develop geothermal energy of late as their lowest cost base-load option going forwards. Yet with gas, hydro, geothermal and wind all on the expansion drawing board in the future, Contact has the broadest possible chance of getting it right going forwards, whichever way the fuel winds flicker.

SNOOPY

[Lizard]

Hi Snoopy,

In regard to asset valuation, I do wonder whether the whole field becomes a bit circular when "fair value" measurement is used rather than cost - i.e. the "fair value" measurement potentially allows assets to be re-valued based on future cashflows... but in a regulatory environment, a "fair return on capital" seems to be considered a basis for determining acceptable pricing.

A few years ago, New Zealand was tight for capacity and the opening up of markets encouraged private investment... now that capacity fears have been allayed, there will be temptations for governments to regulate pricing again and damn the investors that provided for the capacity growth. So it's hard to get too enthusiastic. Of course there is always the prospect of a game-changer - electric vehicles.

[CJ]

In regard to asset valuation, I do wonder whether the whole field becomes a bit circular when "fair value" measurement is used rather than cost - i.e. the "fair value" measurement potentially allows assets to be re-valued based on future cashflows... but in a regulatory environment, a "fair return on capital" seems to be considered a basis for determining acceptable pricing.

Power companies aren't regulated - they are fully competitive.

The key metric for me is cashflow - this is what pays the dividend and is what the share is valued on - yeild and growth. How they value assets is just the accountants justifying their wages.

[Snoopy]

In regard to asset valuation, I do wonder whether the whole field becomes a bit circular when "fair value" measurement is used rather than cost - i.e. the "fair value" measurement potentially allows assets to be re-valued based on future cashflows...

Some might call the whole revaluation of assets of power companies a rort, although as a loyal CEN shareholder I wouldn't use such a term :-).

I think the one thing that is acknowledged, even by the Green Party, is that construction costs do not remain static. Thus if you allowed a hydro power station to sell electricity at historical cost only, the costs recovered would not be enough to renew the asset throughout its working life. The Greens are talking some 'inflation adjustment factor' to be added to the historical power station account cost, when determining a 'fair' rate to charge for power.

but in a regulatory environment, a "fair return on capital" seems to be considered a basis for determining acceptable pricing.

The unknown is, where is 'baseline zero' taken from? IIRC the Clyde Dam was written down to something like $2.2billion when Contact was formed. But of course it was a lot more expensive than that to build it. So maybe if we got right back to original historical cost, the Labour Green's power policy will actually be positive for Contact Energy?

A few years ago, New Zealand was tight for capacity and the opening up of markets encouraged private investment... now that capacity fears have been allayed, there will be temptations for governments to regulate pricing again and damn the investors that provided for the capacity growth. So it's hard to get too enthusiastic. Of course there is always the prospect of a game-changer - electric vehicles.

All those electric vehicles will be charged up at night though will they not? Taking up the 'slack' while demand for electricity is low. Thus no overall increase in electricity generating capacity will be required if the country goes mad for EV?

SNOOPY

[CJ]

All those electric vehicles will be charged up at night though will they not? Taking up the 'slack' while demand for electricity is low. Thus no overall increase in electricity generating capacity will be required if the country goes mad for EV

the lakes only hold so much water which is the majority of our power. Wind and geothermal are unlimited in theory.

[Snoopy]

the lakes only hold so much water which is the majority of our power. Wind and geothermal are unlimited in theory.

I am not sure this is the way to think of the relative importance of hydro/wind/geothermal, at least as far as Contact Energy is concerned.

My contention is that wind and hydro are both theoretically 'unlimited'. But, particularly in the case of wind, they are only unlimited if the daily inputs match the daily outputs. Hydro has a reservoir. That means the matching daily power inputs and outputs are not as critical as matching inter-seasonal inputs and outputs. Wind energy is unable to be stored, at least until someone decides some kind of battery storage system is viable.

Without an associated battery storage system, I would suggest that wind turbines are of no value to an electricity generator. Of course if you combine wind generation assets with hydro and have the ability to switch between the two as a source of power, then wind turbines suddenly have significant value, because suddenly they have a hydro-lake 'battery' in the combined wind/hydro generating system.

Looked at in this context it is interesting that despite having consents for wind farms, Contact Energy has chosen not to build them.

SNOOPY