MCY Mercury NZ ( MRP Mighty River Power)

[Jantar]

In a growth environment the valuation formula is D/(r-g) where D is the annual dividend, r is the required rate of return and g is the rate of growth in perpetuity of the dividend stream.

Your own calculations of growth imply quite a high growth rate. If we assume annual growth in dividends at a lower rate of say 1% p.a. then the valuation is:

23.11c / (0.045 -.01) = $6.60.

This is not too far off the current price so I suspect some players are pricing growth into their dividend valuation as per your earlier post on generation capacity.

Ferg, I have a problem with this method of valuation that perhaps you can explain. Using that formula, if the expected return is low, say 2%, and the sustained growth is equal to the required return, wouldn't that make the value of shares infinite? Or if the growth exceeds this, then the share value would actually be negative.

[Ferg]

But since the actual growth rate is not 1% per year compounding, I don't see any point in modelling the growth this way.

Hi Snoopy

I understand it is easier and more conservative to not model growth in dividends but we do have evidence of growth. I'm not saying you are incorrect in your method, but some people will be factoring in growth which justifies a higher SP, whilst your approach will be more conservative. By the way (D * ((1+g)^10)/r does not equal D/(r-g) - they give differing results depending on the the values of r and g. I know you said 'equivalent' but mathematically they are different.

Per your post above these are the interim and final dividends since 2014:

Year	Nett
	Interim	Final	Total	Gross @ 28%
2014	$0.072	$0.052	$0.124	$0.172
2015	$0.083	$0.056	$0.139	$0.193
2016	$0.084	$0.057	$0.141	$0.196
2017	$0.086	$0.058	$0.144	$0.200
2018	$0.088	$0.060	$0.148	$0.206
2019	$0.091	$0.062	$0.153	$0.213
2020	$0.093	$0.064	$0.157	$0.218
2021	$0.094

I have removed special dividends given they are one off in nature and not part of forward growth.

The CAGR for the gross dividend from 2014-2020 is 4%; $0.172 x (1.04^6) = $$0.218. If we look at a shorter time slice of 4 years, the growth rate is still 2.7% compounding. It is harder to maintain historic growth rates that are based on a low starting value, so 1% does not seem unreasonable.

Also, there is a pattern to the interim and final dividends where each year is slightly higher than the previous. This confirms to me the Board understand the benefit of slow & controlled growth on dividends - there are numerous examples in the USA where dividends have increased every year for decades without skipping a single year. It helps the SP by lowering the dividend valuation denominator for those who use that method. The share prices for such USA companies that have increased dividends annually are eye watering high and the yields are low. But given the "proof of the pudding" in decades of delivery, some investors would view such investments as money in the bank with no regard for the daily or annual SP movements. Different strokes for different folks I guess.

Regards

[Ferg]

Ferg, I have a problem with this method of valuation that perhaps you can explain. Using that formula, if the expected return is low, say 2%, and the sustained growth is equal to the required return, wouldn't that make the value of shares infinite? Or if the growth exceeds this, then the share value would actually be negative.

A fair question.

The model breaks down at the boundaries - but that is assuming the values of r and g are correct, and that this is the correct method to use.

Low rates of r are likely not pricing in sufficient risk when using CAPM methods given r should not be less than the risk free rate (ie return on Government bonds). Also, g is compounding, so compounding growth rates well above the risk free rate would not be common (they would exist but at the margins, given it is hard to grow something FOREVER). But you are correct in that if the required return was low and the growth rate was high, then the price would be infinite. That said, compound growth rates result in very large numbers very quickly. Have a play with a few values of g over differing time periods and you will likely find high values of g do not exist in practice.

Also, compounding growth ad infinitum is rare. Take the example of ATM - very high growth initially but it will slow at some point in the future so pricing should be based on future dividends at a lower growth rate, rather than the high growth rates of today (assuming it was paying a dividend now). Per my post to Snoopy (D * ((1+g)^10)/r does not equal D/(r-g). So in the scenario of high growth you would look past the growth of today at a future dividend and apply the method (D * ((1+g)^x)/r. Whereas something more stable with controlled and managed growth (i.e. a cash cow like a gentailer) would justify using the method D/(r-g).

[Snoopy]

Why have I brought up this topic? Because Mercury thinks it is important!

According to AR2020 p7, the NPS for Mercury Energy is 13.7

For comparison:

1/ The Contact Energy 'Net Promoter Score' is 36 ( CEN AR2020 p12)
2/ The Meridian Energy 'Net Promoter Score' is 6 ( MEL PR2019 p11)
3/ The Genesis Energy Net Promoter Score is -4 ( https://customer.guru/net-promoter-score/genesis-energy)
4/ Trustpower Net Promoter Score is 40 (Infratil March 2017 Presentation)

A second key metric for Mercury Energy management is customer churn. Customer churn is the percentage of customers signing over to another electricity retailer over the financial year.

According to AR2020 p7, the 'trader churn' rate for Mercury Energy is 5.9%.

ADDED: The last customer churn rate I can find is from PR2017 p20. It is 15%

For comparison:

1/ Customer Churn rate at Meridian Energy is 14.2% ( MEL AR2020 p92)

2/ Customer churn rate at Genesis Energy is 15.8%
(https://www.genesisenergy.co.nz/about/media/news/genesis-delivers-earnings-of-$167-million)

3/ Customer Churn rate at Contact Energy is 16.4% (CEN AR2020 p23)

4/ Customer churn rate at Trustpower is 17% (TPW AR2020 p27)

SNOOPY

[Jay]

Which leads us to presume, most stay with Mercury (is this because they were the "original" especially in the wider Auckland region) and of all the others a fair number swap between them on a regular basis
I myself went from Mercury to Contact to Meridian and back the Mecury again - for me the latter have been the best pricing wise, stayed the same deal for a number of years now, where as the other two was a specila deal fixed for a year ot two then they were not cheaper than anyone else.
Ended up back at Mecury as they rang me up and offered me a good deal, so I took it, and when others have rang/come to the door, they go ".. oh that is a good deal, we can't beat it maybe match it..." so no point in changing

[Zaphod]

One of the reasons electricity retailers adopted bundling, was to decrease churn. When you've committed your power, gas, broadband etc. to one supplier it becomes less likely you'll shift to another provider, or so the theory goes.

Looking at the statistics above, that theory doesn't appear to be borne out. Unless Mercury energy customers are predominantly signing up for the expensive electrically powered vehicles and are thereby married to the company for the foreseeable future?

[Snoopy]

One of the reasons electricity retailers adopted bundling, was to decrease churn. When you've committed your power, gas, broadband etc. to one supplier it becomes less likely you'll shift to another provider, or so the theory goes.

Looking at the statistics above, that theory doesn't appear to be borne out. Unless Mercury energy customers are predominantly signing up for the expensive electrically powered vehicles and are thereby married to the company for the foreseeable future?

I have a confession to make. It appears I have been taken in by the old 'massage the statistic' trick. It would seem that Mercury no longer discloses their 'churn rate'. What they have published in AR2020 is 'trader churn'. This is the churn rate for a subset of customers who do not move address. Naturally if you move address you are forced to reset all of your utilities which gives you a good reason to look around at all the options. It is not surprising to me that people who move house change power suppliers more than those who don't. But not publishing customer churn figures does make comparison's difficult. I did find an old Mercury 'customer churn' figure from FY2017. Post 1334 has been updated. Trader churn looks to be near to 5% for FY2017. That would indicate the customer churn figure for FY2020 might be a bit higher than the FY2017 figure of 15%.

SNOOPY

[Snoopy]

A second key metric for Mercury Energy management is customer churn. Customer churn is the percentage of customers signing over to another electricity retailer over the financial year.

The third key metric for Mercury is 'Brand Strength'. According to the Glossary in AR2020 p96

"This measures a brands equity and perception in the market based on a monthly survey. It is a constructed score derived from 5 pillars that are weighted to reflect their impact on the overall Brand Strength. It is reported on a 3 month rolling average and reflects Mercury's Brand Strength amongst customers and non-customers."

Now I would love to tell you what all that means, but I have no idea. And if Mercury aren't going to tell us then I guess we will never know. Anyone out there ever taken part in one of these monthly surveys?

SNOOPY

[Snoopy]

I have removed special dividends given they are one off in nature and not part of forward growth.

I firstly took the same view as Ferg regarding 'special dividends'. However, more recently I took the opposite view and decided to include the historical special dividends in my future dividend payment forecasting. Not saying Ferg is wrong as I can see the case for both opinions. But right now I am in the 'include special dividends' group.

Out of curiosity I went back to investigate what management said about each special dividend that has already been paid to share holders at the time,

11th December 2014: Special Dividend 5cps ($69m). A successful $300m Capital Bond Offer made the dividend 'part of the capital management plan'.
(from https://stocknessmonster.com/announc...cy.nzx-257282/) (also AR2015 p15).

During this year (FY2015), the closure of the Southdown gas fired power station was announced and a write down of $44m was taken

30th September 2015 Special Dividend 2.5cps ($34m). "part of an ongoing focus on capital management while retaining some balance sheet flexibility. (AR2015 p15)

30th September 2016 Special Dividend 4.0cps ($56m). "Continuing focus on active capital management and limited requirement for growth capital". (AR2016 p8).
During the year, $13m was received from disposals of land, including parcels around the site of the former Marsden Point power station to the office of treaty settlements.

29th September 2017 Special Dividend 5.0cps ($70m). "No value enhancing investments were found and the proceeds of (surplus) carbon credit sales were received" (AR2017 p14) (cash proceeds of $26m and profit of $5m). The surplus carbon credits were no longer needed due to the shutting down of Southdown.

One thread that goes through the whole time that special dividends were being paid was Southdown. Nevertheless if we consider in FY2014, the initial write-down of Southdown, that loss more than wipes out any downstream subsequent profits to EOFY2017. So it seems the more likely explanation for 'surplus capital' is the acquisition of the alternative funding mechanism of debt on favourable terms.

Given that $300m of Capital Bonds at 3.6% funding have replaced the $300m of July 2019 bonds funded at 6.9% and a smaller $31m of Wholesale Bonds at 8.21% have also rolled off during this financial year, my opinion is that once Turitea is up and running, the special dividends could resume. There is also a speculative special dividend of some 10cps awaiting if MCY were to sell their Tilt Renewables stake. So is it wrong to leave the special dividends out when MCY has an historical precedent for paying them as 'capital management' is adjusted?

SNOOPY

[Snoopy]

'Mercury Energy', the former 'Mighty River Power' have a goal to be "New Zealand's leading Energy Brand". Mercury reported they gained a net 16,000 customers over FY2017. Mercury generated 19% of NZs power over FY2017 and supplied power to 14% of all retail customers.

End of financial year 2017 figures:

https://www.emi.ea.govt.nz/Retail/Re...ucture,p|1,v|3

shows that Mercury's sold 19.0% of power generated, only behind Contact Energy (20.4%) and Genesis Energy (24.5%), well clear of Meridian Energy in fourth place.

The tangible expressions of the 'leading energy brand' aim, can be covered in three 'foundation principles'.

1/ Well being of Mercury Energy people (measured engagement is now 81%, up from 79% the previous year) and customers (level of switching to other retailers is 17.8%, claimed to be the lowest of the big players). Perhaps some of the secrets of keeping customer engaged are 'Airpoints', 'Free Power days' (offered over the phone as part of the 'personal touch') and 'Fixed Price Contracts' to provide certainty. 34% of residential and 63% of commercial customers are signed up for those! Mercury have financially supported the development of the walking/cycling recreational trail along the Waikato River.

2/ Respect for "kaitiakitanga' (custodianship of equal resources). The Waikato river catchment, which houses all of Mercury's hydro dams, is ecologically monitored by Mercury. This includes monitoring of riverbed sediment and the riverbanks including downstream of Karapiro the 'last in line' hydro dam. Mercury keeps compliance with 121 hydro related consents and can mitigate the effects of flooding and droughts by controlling water release from the Waikato dam system.

"Kaitiakitanga' also covers working with the 'Waikato Tainui', 'Raukawa', 'Ngati Tahu - Ngati Wharoa' and 'Ngati Tawharetoa' iwi. These iwi relationships also cover the tribal geothermal resources harnessed by Mercury Energy in geothermal plant joint ventures.

3/ Making commercially astute decisions: Mercury have an integrated management approach to the operation of their hydro and geothermal stations.

Conclusion: Pass Test

Mercury Energy is one of the top four gentailers servicing the New Zealand energy market. It is number three in terms of customers but it is not in the top three in terms of energy generation. However, Mercury's mission, "To be New Zealand's leading energy brand" is not just dependent on sales and generation numbers.

	No. NZ Customers EOFY2020	NZ Power Station Electricity Generation (TWh)
Contact Energy	510k	8.5
Genesis Energy	435k	6.8
Mercury Energy	348k	6.3
Meridian Energy	324k	14.2

From a customer perspective, the three primary goals are to have low 'customer churn', a high 'net promoter score' and good 'brand strength'. The comparisons I make are with the other NZ gentailers.

Customer Churn (refer my post 1334)

With a probable figure in the low to mid 15 percent range (the actual figure has not been released for a few years), Mercury is likely in second place, behind Meridian at 14.2% but ahead of Genesis at 15.8%.

Net Promoter Score (refer my post 1328)

Mercury is in third place with a score of 13.7, behind Trustpower on 40 and Contact Energy on 36

Brand Strength (refer my post 1338)

Mercury have not revealed the five key pillars they use to measure this. However, I do believe their bright yellow branding gets attention. And the 'kiss oil goodbye' campaign, along with Mercury Energy's poster car for electric transport Evie (A 1957 Ford Fairlane Convertible converted to electric power) certainly sticks in my memory.

CONCLUSION: Pass Test

SNOOPY