Contact Energy - CEN Chart

[Snoopy]

8.2PJ x $9.73m = $79.8m (before tax) = $79.8m * (1-0.28) = $57.4m (after tax)

There are 718.67m CEN shares on issue. So if the dividend went up incrementally by $57.4 / 718.67 = 8cps, that should be sustainable in years with a reasonable rainfall profile.

Final dividend last year was 12cps, so 12cps + 8cps = 20cps

Sounds like a nice round final dividend number to me :-)

The FY2012 result presentation details a rapid projected fall off in capital expenditure going forwards. Last year it was $583m, this year forecast as $380m. Then it decays like this: $290m, $200m, $120m, $100m, in the ensuing four years.

Some have speculated that this will allow even higher dividends in the future. Bank debt at EOFY2012 was reasonably significant in relation to earnings, standing at $1.303billion. ROE was only 5.2%. So I would argue that the safest way to improve earnings going forward would be to pay down debt. Granted interest rates are low now, but this may not be the case five years out. And there is the spectre of the Labour/Green coalition putting a halt to some of the revenue CEN might otherwise expect.

In my judgement CEN will not want to increase dividends above their core earnings gains simply because the whole power sector is living in uncertain times. As a shareholder in it for the dividends however, I do hope that other sharetrader contributors can convince me that I am wrong!

SNOOPY

[Snoopy]

Ok Im biased...but why would one sell CEN..at low $4.90 ......CEN pays nearly 5 % div and have indicated it will increase to whatever....Am I missing something...

hold about 8k

OK time to dive into my rather crude five year dividend model and see what value it spits out for CEN. The five year dividend record for Contact Energy is a follows (year, interim dividend cps, final dividend cps):

2009: 11, 17
2010: 11, 14
2011: 11, 12
2012: 11, 12
2013: 11, 20*

*= my forecast

That comes to a grand total of $1.30, or an average of 26cps.

Generally I go for an 8% dividend yield. However in the case of a utility like this where demand is rather inelastic, I believe 6.5% is more appropriate.

26/0.065 = $4.00

This share price reflects the fact that the dividends over the last five years have been modest in historical terms. Based on a one year payout of 31c (my forecast), the share price should be:

31/0.065 = $4.77

Of course both of these valuations assume zero growth forever. But if we get zero overall market growth for say eight years, that is forever in sharemarket terms.

So there is you reason to sell at $4.90 troyh. Some would say that at $4.90 the share price is being held up by the low interest rates currently available to depositors. You could construct an argument for selling out and buying back in later once interest rates rise.

SNOOPY

discl: hold CEN

[CJ]

However in the case of a utility like this where demand is rather inelastic, I believe 6.5% is more appropriate.

6.5% net is about 9% gross. Compared to 4% at the bank.

Seems a bit high though you assume no growth so the higher rate may be justified to account for risk.
. **

[Snoopy]

... 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.

I have run some back of the envelope calculations on what might be regarded as 'fair value' for Contact's assets.

The station that has just finished construction is Te Mihi, a new standalone generator site that plugs into the Wairakei geothermal field. Cost all up was $623m, for a power station rated at 166MW. Generally the higher the power rating of the power station the more individual gas turbine units will be contained within it.

When it comes down to it, all of Contact's power stations can be reduced to 'something' driving a turbine. In the case of geothermal that 'something' is usually steam containing some level of mineral impurities. A turbine working in those conditions is IMO unlikely to be a cheap one. Perhaps special alloys are needed that would boost the turbine cost well over and above something that would operate at ambient temperature with purer water (as in a hydroelectric dam)?

Another factor that would make a hydro turbine cheaper to run over the long term would be that when replacement time comes the old one could theoretically be unbolted and a new one put in. With a geothermal field it is more likely that further drilling will have to take place to find the optimum 'hot spot' and that a whole new station will have to be built at a new location.

The greens/labour have been trumpeting excessive profits being generated by overvalued assets. But I think there is an argument that says turbines do eventually wear out. So I am of the opinion that the turbine equipment needs to be thought of as carrying it's replacement value on the books for power pricing purposes. This is necessary to ensure that when a replacement is eventually required the capital replacement budget exists that will ensure the power station can keep running.

Using these ideas I now present my current replacement cost valuation of CEN generation assets:

Te Mihi (geothermal) 166MW $623m
Remaining Wairakei (geo) 120MW $300m
Ohaaki (geo) 104MW(design capacity) $400m

Te Rapa Cogeneration (gas) 44MW $100m
Otahuhu B (gas) 400MW $600m

Clyde (hydro) 440MW $600m
Roxburgh (hydro) 320MW $450m

Note that the book value of Clyde and Roxburgh relate to the turbines and their immediate containments, not the dams themselves and any associated stabilizing earthworks.

I get a total turbine cost of $2473m, say $2.5b round figures.

The cost of building the Clyde dam was around $4b including $1b of overruns. However it was transferred to Contact at around $1.7b. The cost of the Roxburgh earthworks was possibly $2b in Clyde terms, which probably reduces to $200m in 1962 dollar equivalents.

So if we add that $1.9b of historic adjusted earthwork costs to the turbine assets I get $4.4b. Property plant and equipment assets are valued at $5b on Contact's books. I think one could easily make a case for $600m plus of inflation adjustment dam construction value to be added to the historic cost dam figures.

So I would argue that even if the labour greens form the next government, the book value of Contact Energy assets will be unaffected by the new power policy. Given Contact produced an ROE of under 6% in 2012 based on book value, which translates to an ROA of some 5%.... How can that be regarded as excessive?

OK I am sticking my neck out. I don't believe a labour/green power policy if implemented will have any effect on Contact Energy.

SNOOPY

[Snow Leopard]

I...Generally the higher the power rating of the power station the more individual gas turbine units will be contained within it....

The more individual turbines maybe,
but in the power industry a gas turbine [power generation set] is essentially a jet engine coupled to a generator which is used at times of peak demand as they:
a) can be fired up from off to full load quickly;
b) are expensive to run.

When it comes down to it, all of Contact's power stations can be reduced to 'something' driving a turbine.

which drives a generator

In the case of geothermal that 'something' is usually steam containing some level of mineral impurities. A turbine working in those conditions is IMO unlikely to be a cheap one. Perhaps special alloys are needed that would boost the turbine cost well over and above something that would operate at ambient temperature with purer water (as in a hydroelectric dam)?

For geothermal the hot water/steam from the ground which has you say is full of stuff does not directly drive the turbines. It is passed through a heat-exchange unit to heat a more benign liquid/gas in a closed system that then drives the turbine.

Another factor that would make a hydro turbine cheaper to run over the long term would be that when replacement time comes the old one could theoretically be unbolted and a new one put in. With a geothermal field it is more likely that further drilling will have to take place to find the optimum 'hot spot' and that a whole new station will have to be built at a new location.

If you heat source depletes then yes you need to re-drill but replacing a turbine is straight-forward at a geo-thermal site.

Best Wishes
Paper Tiger

[Snoopy]

The more individual turbines maybe,
but in the power industry a gas turbine [power generation set] is essentially a jet engine coupled to a generator which is used at times of peak demand as they:
a) can be fired up from off to full load quickly;
b) are expensive to run.

Paper Tiger, I believe you are correct. I wrote 'gas turbine' but was actually thinking more 'turbine' in general. However, although gas turbines are expensive to run they are (relatively) cheap to build. And you can build them anywhere, and that means close to NZs largest market (Auckland). So taking into account all costs, I would not say that gas turbines are necessarily expensive. Indeed Contact's Otahuhu B was designed as primarily a base load station. But of course that was in the days of the Maui gas field in full production, and Contact having take or pay contracts to buy gas from Maui and nowhere to store it. Otahuhu B has four individual gas turbine / generator sets IIRC.

SNOOPY

[Snoopy]

If you heat source depletes then yes you need to re-drill but replacing a turbine is straight-forward at a geo-thermal site.

When I wrote about redrilling, I was thinking specifically about Te Mihi being re sited at another part of the Wairakei geothermal field to be closer to the heat source. I was thinking that this was probably because the geothermal field had changed since 1958. But it may have been because a superior access point was always there, but not known in the 1950s when Wairakei was established. Since Wairakei was the world's earliest geothermal power station the jury may still be out as to whether redrilling and rebuilding is a better option that just replacing a turbine on site. I guess the point I was making is that re siting a geothermal power station is more likely than resiting a hydro dam or a wind farm. I admit though that this may be because of our generally less than perfect knowledge of geothermal fields, rather than anything inherent in geothermal technology per se.

SNOOPY

[Snoopy]

which drives a generator

Yes all power generating turbines drive a generator. But a generator is not subject to any special wear and tear which is dependent on the medium (water, steam, natural gas) indirectly driving it. It may be subject to many more stop starts in a peaking station. But that is not what we are talking about here. I don't believe the generator is something that should concern us when comparing different power station technologies.

For geothermal the hot water/steam from the ground which has you say is full of stuff does not directly drive the turbines. It is passed through a heat-exchange unit to heat a more benign liquid/gas in a closed system that then drives the turbine.

I accept that using a heat exchanger to pass the energy to a more benign liquid/gas in a closed system makes a lot more sense than pulling geothermal eruptions straight out of the ground to use, impurities and all! Quite right to pull me up on that Paper Tiger.

The point I was trying to make was that with geothermal energy there is some part of the power generation system that will be exposed to whatever is being pulled out of the ground. This is likely to be more chemically corrosive than pure water. It is very likely this part of the power generation process will be 'high wear' and require either more maintenance or more corrosion resistant construction. Either one will increase the capital and or running costs of a geothermal plant 'unit' over and above the costs of a hydro turbine 'unit' of equivalent output.

Your point that the actual turbine may not be subject to higher material stress PT, is well made. However, this actually strengthens my point. I was assuming that the entire cost of producing a geothermal plant might be up to 50% higher (on a generator output basis). I still believe such costs will be higher in a geothermal plant. But if only a small amount of the pipework needs uprating, maybe the costs are only 10% higher overall. That in turn means that if I base my replacement construction costs for the 'non-geothermal' turbine/generator system on the known costs at Te Mihi minus 33% , I have underestimated those 'non-geothermal' turbine/generator system replacement costs. So the asset value on the books, adjusted for inflation as Greens/Labour would have us do - at CEN- is even less likely to be overdone than I have previously calculated.

SNOOPY

[Snoopy]

6.5% net is about 9% gross. Compared to 4% at the bank.

Seems a bit high though you assume no growth so the higher rate may be justified to account for risk.
. **

CJ I agree with you. Redoing my calculation on a 9% gross interest rate.

2009: 11, 17
2010: 11, 14
2011: 11, 12
2012: 11, 12
2013: 11, 20*

*= my forecast

That comes to a grand total of $1.30, or an average of 26cps, or 37cps gross.

With a 6.5% 'utility' interest rate that gives a share price valuation of

37/0.065 = $5.69

Or based on my forecast dividend payment (44c gross) for this year only

44/0.065 = $6.77

Those two valuations are closer to where Lizard is valuing CEN, although personally I think that $6.77 upper bound of mine is optimistic and unreliable, based as it is on a single years potential dividend.

SNOOPY


PS Previous valuation calculation below for comparative purposes

Generally I go for an 8% dividend yield. However in the case of a utility like this where demand is rather inelastic, I believe 6.5% is more appropriate.

26/0.065 = $4.00

This share price reflects the fact that the dividends over the last five years have been modest in historical terms. Based on a one year payout of 31c (my forecast), the share price should be:

31/0.065 = $4.77

[Snow Leopard]

Paper Tiger, I believe you are correct. I wrote 'gas turbine' but was actually thinking more 'turbine' in general. However, although gas turbines are expensive to run they are (relatively) cheap to build. And you can build them anywhere, and that means close to NZs largest market (Auckland). So taking into account all costs, I would not say that gas turbines are necessarily expensive. Indeed Contact's Otahuhu B was designed as primarily a base load station. But of course that was in the days of the Maui gas field in full production, and Contact having take or pay contracts to buy gas from Maui and nowhere to store it. Otahuhu B has four individual gas turbine / generator sets IIRC.

SNOOPY

Sorry, when I saw gas turbine I just thought peaking set, my bad.
Otahuhu and similar are more complex beasts designed to achieve a higher efficiency, look up ?combined cycle? gas turbines if you are interested.

Wish I could provide information with regard to construction and operational costs for different types of generation for you.

Best Wishes
Paper Tiger

Disc: In a past life I have been involved with many utility companies including electricity generation, transmission and distribution in both New Zealand & Australia