GNE - Genesis Energy

[Snoopy]

Of more medium term concern is a likely rise in NZ interest rates from all time lows. That alone will affect the 'Discount Rate' (AR2016 p46) applied to future profit streams that are used to value these power stations. Thus in the medium term, I think there is a real chance that the value of some of these hydro assets will decrease. Consequently, I don't believe it is wise to build an investment case assuming these hydro assets will increase in value in the medium term.

An interesting little aside here on 'discount rate'.

Under 'Property Plant and Equipment' valuation comments GNE AR2016 p46

"...unobservable inputs in the valuation model were:

<snip>

Discount Rate. Pre-tax equivalent discount rate of 10.8%. Discount rate is independent of wholesale electricity prices and generation volumes."

Under "Goodwill and Asset Impairent Testing", from the CEN AR2016 p66

"Determining value in use involves estimating future cash flows for each CGU ('Cash Generation Unit'). The cashflows are adjusted for future growth based on historical inflation and discounted at a post tax discount rate of 7-9% to arrive at present value, or recoverable amount of each CGU."

8% (to take the mid point) and nearly 11% is a huge discrepancy in assumption between two broadly similar (?) companies operating in the same market. A 3% discount rate valuation difference represents nearly a billion dollars in asset valuation (or a non-trivial $1 per share, spread over the one billion GNE shares in existence) booked on the Genesis Energy balance sheet. Has anyone got an inkling as to what might cause such a discount rate valuation discrepancy between the two companies?

SNOOPY

PS Genesis AR2016 p46 (again). The wording of the sensitivity analysis seems to say that if the discount rate rises from 10.8% to 11.8%, then the result is an increase in asset values of $373m. I would have thought that if the discount rate increases then the value of those generation assets should fall by $300m. Am I reading that table correctly?

[Beagle]

So with the recent slight bounce in the SP and finding that real profit is only close to half what was paid in dividends, (no longer fully imputed as foreshadowed by this hound), and with the medium term outlook for interest rate increases is Snoopy still content to hold ?

[Snoopy]

An interesting little aside here on 'discount rate'.

Under 'Property Plant and Equipment' valuation comments GNE AR2016 p46

"...unobservable inputs in the valuation model were:

<snip>

Discount Rate. Pre-tax equivalent discount rate of 10.8%. Discount rate is independent of wholesale electricity prices and generation volumes."

Under "Goodwill and Asset Impairent Testing", from the CEN AR2016 p66

"Determining value in use involves estimating future cash flows for each CGU ('Cash Generation Unit'). The cashflows are adjusted for future growth based on historical inflation and discounted at a post tax discount rate of 7-9% to arrive at present value, or recoverable amount of each CGU."

For further comparative purposes in valuing assets, Mercury Energy (MCY AR2016 p59) uses a discount rate of 7.4 - 7.9% (within bound but on the low side of the Contact Energy figure).

Meridian Energy OTOH uses a different method incorporating a suitable EBITDAF multiple of 12 (MEL AR2016 page 67). That is a different approach to take, as it assumes a market biased approach to a single year forward looking perspective. Not a good way to evaluate the true value of long lived hydro assets, I would have thought!

SNOOPY

[Snoopy]

So with the recent slight bounce in the SP and finding that real profit is only close to half what was paid in dividends, (no longer fully imputed as foreshadowed by this hound), and with the medium term outlook for interest rate increases is Snoopy still content to hold ?

If the market value of GNE generation assets (after the FY2016 revaluation upwards) is really one billion more ($1 per share more) than the book value shown in the AR2016 accounts, then this may very well influence my buy/sell decision making!

SNOOPY

[Jantar]

Under 'Property Plant and Equipment' valuation comments GNE AR2016 p46


..... Pre-tax equivalent discount rate of 10.8%. .......

from the CEN AR2016 p66
....... a post tax discount rate of 7-9%

....

Considering one is pre tax and the other is post tax I would have thought that they were pretty similar.

[fish]

If the market value of GNE generation assets (after the FY2016 revaluation upwards) is really one billion more ($1 per share more) than the book value shown in the AR2016 accounts, then this may very well influence my buy/sell decision making!

SNOOPY

Thank you so much snoopy for sharing your research.

I am so glad I sold most of my nzo,some of my AIR and have been building up CEN and to a lesser extent GNE.
The world is truly unpredictable.
We are so lucky here.
I have a feeling(not a prediction) that We are about to see more immigration from California and England.
We might even see an increase in electricity demand and no one prepared to invest more in generation.
Whatever happens I am going to keep getting good dividends.
The SP is likely to be volatile for sometime to come .
In the meantime I am going to avoid trading,not look at the SP and instead focus my interests elsewhere

[Snoopy]

Considering one is pre tax and the other is post tax I would have thought that they were pretty similar.

GNE: post tax discount rate (1-0.28) x 10.8 = 7.8
CEN: post tax discount rate of 7 to 9%
MCY: post tax discount rate of 7.4 - 7.9%

Yes everything looks more consistent expressed in post tax terms. It is goodbye to the hidden $1b windfall of Genesis Assets hidden on the books though :-(

SNOOPY

[Snoopy]

So with the recent slight bounce in the SP and finding that real profit is only close to half what was paid in dividends, (no longer fully imputed as foreshadowed by this hound), and with the medium term outlook for interest rate increases is Snoopy still content to hold ?

Compared to Contact (CEN AR2016 p63), Genesis Energy is not very forthcoming on the exact interest rates attributable to the individual parts of their borrowings (GNE AR2016 p51,53).

The next big blocks of bank credit to expire looks like at not insignificant $125m of notes in 2017 and $175m at an unknown interest rate in July 2018. I would guess significant interest savings are on the cards from rolling over those historical loans , even if our own interest rates have started to rise again by then (Contact borrowings expiring around that time period have coupon rates of about 7%).

SNOOPY

[Snoopy]

Time to rerun the Kupe valuation model (natural gas component) , this time using the 2P production chart in the NZOG FY2016 annual report.

Year	Kupe Gas	Value	Resource Depreciation	Net
	(GJ)	Received	and Amortization	Proceeds
2017	5.80E06	$38,616,400	$15,364,253	$23,252,147
2018	6.10E06	$37,770,834	$14,288,755	$23,482,079
2019	6.00E06	$34,551,025	$13,288,542	$21,262,483
2020	5.70E06	$30,525,831	$12,358,344	$18,167,487
2021	5.70E06	$28,389,023	$11,493,260	$16,895,763
2022	5.70E06	$26,401,791	$10,688,732	$15,713,459
2023	5.70E06	$24,553,666	$9,940,521	$14,613,145
2024	5.30E06	$21,232,459	$9,244,684	$11,987,775
2025	5.80E06	$21,609,035	$0	$21,609,035
2026	5.80E06	$20,096,403	$0	$20,096,403
2027	5.80E06	$18,699,454	$0	$18,699,454
2028	4.50E06	$13,485,552	$0	$13,485,552
Total	6.79E07	$315,921,673	$96,667,090	$219,254,583
PV per share				$0.22
PV per share (tax paid)				$0.16

There is something troubling about my above valuation of Kupe (gas). There is a nice decay(*) of a depleting resource going out into the future until 2024 (see last column of table). By 2025 the net value of recovered gas suddenly doubles, even though production remains less than 10% higher than the previous year. So what is happening here?

In the small print of the Genesis Energy AR2016 on page 48 we find the following note:

"Depletion of Oil and gas producing assets excluding major inspection costs is calculated on a unit of production basis using the proven remaining reserves (1P)..."

However, when the Kupe field had its reserves upgraded, all the talk was about the greater 2P reserves now available. Further down on AR2016 p48 we learn something interesting about 'Proven Reserves'

"Proven reserves are those which have a 90% likelihood of being delivered."

So even 'proven reserves' are not considered a given. Notwithstanding this, the table that I have produced is actually a mismatch: Offsetting 2P revenue against 1P field depletion costs. So is my table really a long list of numbers that is really a waste of time? I would argue 'no' for the following reasons:

1/ 2P reserves are still the most probable measure of actual reserves. But we won't know that for sure until Kupe nears the end of its production life.
2/ There is no estimate given of 2P final production costs. And I don't have sufficient technical expertise to make a good guess.
3/ Offsetting field 1P depletion against 2P production will give a slightly lower field net value than if I was able to offset 2P depletion against 2P production. That's because writing off depletion charges sooner means these charges carry less of a time value of money discount. So my overall valuation of Kupe is slightly less than what it should ultimately turn out to be. Generally having a valuation of the conservative side is better than having an overoptimistic valuation from an investor perspective.

Conclusion: Baring better information becoming available, I will stick with the Kupe valuation that I have done.

(*) the obvious immediate exception being 2017 and 2018 in which the latter year is higher. This is because of lower production scheduled in FY2017 because of planned shut down and maintenance work.

SNOOPY

[trader_jackson]

https://www.nzx.com/companies/GNE/announcements/292744

So... increase in dividends?

Looks like snoopy you'll be re-doing your valuations!