MCY Mercury NZ ( MRP Mighty River Power)

[Dassets]

First big day back at abnormal work day after the summer break and anniversary weekends in wgtn and akl. We are already seeing high 200s and that isnt even peak. I have now said a couple of times that without significant rainfall we will move into the 10% risk zone in May or June from my calculations. That means compulsory savings. Average rainfall will not save us in my simulation. The only chance ia thermal keeps going flat out. But that prob will only reduce prices to circa 200. Recall March 17 qtr only averaged high 40s lo 50s. At some point the consumers will feel it and this will becone very political.

The only answer I see is split retail from generation which would allow merchant generators to sensibly enter the market. Good for almost everyone.

[Snoopy]

The 'Buffett Growth Model' works by looking at what a company is able to do with its retained earnings. The more earnings they retain to reinvest at a high ROE, the more the value of the business is liable to grow over future years. So a key question to identify is, what level of earnings are retained by Mercury?

Answer: None

5/ Over the study period, dividends have greatly exceeded earnings, and consequently no earnings have been retained.
6/ According to the Buffett model, this means MCY will not grow in the future. It will shrink!
7/ This brings into question whether the Buffett Growth model is appropriate for valuing this company.

Traditionalists will recognise two ways to raise money for new investments.

1/ Retain profits within your company to allow you to reinvest that capital
2/ Make a share placement to draw new capital into the business.

Both of these involve real money. However, as owners of Mercury Energy will know, we shareholders have discovered a third way of capital raising, where no money has to be put up at all. This is called 'thin air capital', although Mercury executives, do not describe it in such terms. The basic idea is to raise by decree the value of existing generation assets because of their future earning potential. This raises the equity value of the company, and allows more borrowing for investment. 'Thin air capital' is the key to Mercury being able to build new geothermal power stations without raising any new money. Unfortunately the Buffett growth model makes it difficult to incorporate 'thin air capital'. So I am going to go back to how I valued MCY last year, albeit with a couple of tweaks.

SNOOPY

[horus1]

There is only one problem and that is that the cost of new generation is DECREASING. There should be an impairment against the asset values. The gravy train is over.

[Snoopy]

Financial Year	EBITDAF	less Adjustment	less DA	less I	times 0.72= Normalised NPAT	eps
2013	$391m	-($16.4m + $4.2m)	$150m	$57m	$147.1m	10.5cps
2014	$504m		$161m	$84m	$186.5m	13.3cps
2015	$482m	$17m/0.72	$170m	$99m	$136.4m	9.7cps
2016	$493m	$13m/0.72	$182m	$97m	$141.1m	10.1cps
2017	$523m	$5m	$189m	$95m	$168.5m	12.0cps

Notes:

1/ 'eps' figures based on 1,400m share being on issue
2/ FY2013 earnings modified by adding back IPO costs and loss on sale of German Geothermal Asset.
3/ FY2015 and FY2016 earnings reduced by property/land sale profits (adjusted to reflect that non-core property land sales are not generally taxable.)
4/ FY2017 result adjusted to remove profit on carbon credit sales.

To calculate a 'Normalised earnings' average I am going to use the figures for the last four years only. That is because during FY2013, the Ngatamariki Thermal Station was only just coming on stream. That means business conditions in FY2013 are probably not reflective of any future MCY business scenario. The averaged normalised eps for FY2014 to FY2017 inclusive is therefore:

(13.3 + 9.7 + 10.1 +12.0)/4 = 11.3cps

SNOOPY

[Snoopy]

Financial Year	eps	Dividend Paid (per share)	Ordinary Dividend Paid (per share)
2014	13.3c	7.2c + 5.2c = 12.4c	7.2c + 5.2c = 12.4c
2015	9.7c	8.3c + 5.0c + 5.6c = 18.9c	8.3c + 5.6c = 13.9c
2016	10.1c	8.4c + 2.5c + 5.7c = 16.6c	8.4c + 5.7c = 14.1c
2017	12.0c	8.6c + 4.0c(NI) + 5.8c = 14.4c +4.0c (NI)	8.6c + 5.8c = 14.4c
2018		8.8c + 5.0c(NI) + ?c = ?	8.8c + ?c = ?
Total FY2014 to FY2017		62.3c + 4.0c (NI)	55.1c

Notes:

1/ The above 'per share' table is based on the 1,400m MCY shares on issue.
2/ (NI) means 'Not Imputed'

For valuation purposes I intend to work with the ordinary dividend. I do this because doing so incorporates a 'management judgement' of what management thinks normal earnings are. The special dividends that I haven't counted I consider 'capital adjustments' to restore the company to management's desired equity ratio. I do not think that these special; dividends will be indicative of future payments.

From the table, the average annual normalised dividend payment has been: 55.1c/4 = 13.8c. However, I prefer to use the latest available data. In this instance this means I drop the final dividend payment for FY2013 (which was paid in FY2014) of 7.2c, and replace it with the final dividend paid for FY2017 (paid in FY2018) of 8.8c. So my four year tax paid normalized dividend average becomes:

( 5.2c +(8.3c + 5.6c) + (8.4c + 5.7c) + (8.6c + 5.8c) + 8.8c) /4 = 14.1c

SNOOPY

[Marilyn Munroe]

Snow storage in Meridian’s catchment looks to be lower than anytime since 1987! https://www.meridianenergy.co.nz/abo...s/snow-storage

Here is a link to a story in the Timaru Herald which backs up your lack of snow storage claim in the Waitaki catchment;

https://www.stuff.co.nz/environment/...y-bare-of-snow

Boop boop de do
Marilyn

[fish]

Snoopy you have analysed past dividends and explained a kind of creative accounting that has us all wondering how it can continue.
Contact and Genesis are basing future dividends based on free cashflow.Is this what mercury is actually doing but using special dividends to payout surplus cash in years of high profit whilst having a normal dividend that goes up more slowly-maybe in keeping with inflation and improved efficiency?
Should free cash flow and demand reaches a level that allows the building of new generation then it may disappear for a time.

[blackcap]

There is only one problem and that is that the cost of new generation is DECREASING. There should be an impairment against the asset values. The gravy train is over.

Then why are power prices still so high? Solar is still very expensive and wind is not economic. Nuclear may be the only way to go looking forward but we know that is not going to happen in NZ.

[Snoopy]

I am going to use the assumption that, following the completion of the most recently commissioned Ngatamariki geothermal station in FY2013, Mercury considered itself 'capital optimised'. Using the balance sheet from that year, we can therefore calculate an optimised gearing ratio for the company:

Optimised Gearing ratio: (Total Liabilities)/Total Assets): $2,620m / $5,802m = 45%

The 'thin air capital' accumulated by Mercury since FY2013 is as follows:

Year	New Thin Air Capital	Post Tax Effect Multiplier	Effective New Thin Air Capital
FY2014	$40m	0.72	$28.8m
FY2015	$497m	0.72	$357.8m
FY2016	$106m	0.72	$76.3m
Total			$463m

The total of this 'thin air capital' that has been accumulated could theoretically support extra debt 'd' according to the company's optimised gearing ratio.

'd' / $463m = 45% => d=$209m

We thus have a total of amount of: $463m + $209m = $672m available to build a new geothermal power plant. Compare this to the $475m cost of building the Ngatamariki 85MW thermal plant in FY2013. I think there should be enough capital available to build a new 100MW plant in FY2017, provided Mercury has not returned any of this 'thin air capital' to shareholders in the meantime.

I should point out that Mercury currently has no plans to build such a plant. I am merely pointing out that they could. Furthermore because they have the relevant consents, eventually I believe they will. So how do we reflect the potential to build this new power station in today's valuation? This will be determined by the 'effective power generating capacity' ( maximum capacity x expected time ultilisation ) of all of the existing generation capacity.

1044MW Hydro (existing) x 0.514 = 537MW (effective)
463MW Geothermal (existing) x 0.940 = 435MW (effective)
100MW Geothermal (theoretical new) x 0.940 = 94MW (potentially effective)

Hence the potential effective new theoretical capacity increase is:

94 / (537+435) = 10%

Since the overall market would have expanded by the time this new station was commissioned, I would argue that this thin air capital generated since EOFY2013 represents an increase in value of 10% based on the underlying worth of the company today. So my final EOFY2016 valuations are:

$2.66 x 1.1 = $2.93 (based on averaged, normalised eps)

$2.45 x 1.1 = $2.70 (based on averaged, normalised ordinary dps)

Note that I have not incremented my third valuation of $2.75 which included special dividends. In my assessment the 'special dividends' are effectively a return of capital, or more specifically a 'return of thin air capital'. Thus putting an incremental multiple on that figure would be equivalent to 'double counting'.

Summary:

I value MCY as worth between $2.70 and $2.93 (ex-dividend). At $2.93 on the market today, I consider MCY to be at the top end of fair valuation. It is nowhere near overvalued enough for me to consider selling though. By contrast if I was buying, I always like to buy in slightly below fair value. My target buy in price, based on a dividend yield of 6.5% would be:

$2.49 to $2.70.

Right now, I'm neither selling nor buying.

I am going to use the assumption that, following the completion of the most recently commissioned Ngatamariki geothermal station in FY2013, Mercury considered itself 'capital optimised'. Using the balance sheet from that year, we can therefore calculate an optimised gearing ratio for the company:

Optimised Gearing ratio: (Total Liabilities)/Total Assets): $2,620m / $5,802m = 45%

The 'thin air capital' accumulated by Mercury since FY2013 is as follows:

Year	New Thin Air Capital	Post Tax Effect Multiplier	Effective New Thin Air Capital
FY2014	$40m	0.72	$28.8m
FY2015	$421m	0.72	$303.1m
FY2016	$136m	0.72	$97.9m
FY2017	$48m	0.72	$34.6m
Total			$464m

Note that compared to last year I have modified my approach. I have taken into account some impairments that I did into include before. By chance and with the extra year of revaluations, I have ended up with the same optimised gearing as last year! I haven't 'corrected' last years result though, because some of these changes are judgement issues and not necessarily 'right' or 'wrong'.

The total of this 'thin air capital' that has been accumulated could theoretically support extra debt 'd' according to the company's optimised gearing ratio.

'd' / $464m = 45% => d=$209m

We thus have a total of amount of: $464m + $209m = $673m available to build a new geothermal power plant. Compare this to the $475m cost of building the Ngatamariki 85MW thermal plant in FY2013. I think there should be enough capital available to build a new 100MW plant in FY2018, provided Mercury has not returned any of this 'thin air capital' to shareholders in the meantime.

I should point out that Mercury currently has no plans to build such a plant. I am merely pointing out that they could. Furthermore because they have the relevant consents, eventually I believe they will. So how do we reflect the potential to build this new power station in today's valuation? One way could be determined by the 'effective power generating capacity' ( maximum capacity x expected time ultilisation ) of all of the existing generation capacity.

1044MW Hydro (existing) x 0.514 = 537MW (effective)
463MW Geothermal (existing) x 0.940 = 435MW (effective)
100MW Geothermal (theoretical new) x 0.940 = 94MW (potentially effective)

Hence the potential effective new theoretical capacity increase is:

94 / (537+435) = 10%

Since the overall market would have expanded by the time this new station was commissioned, I would argue that this 'thin air capital' generated since EOFY2013 represents an increase in value of 10% based on the underlying worth of the company today. So my final EOFY2017 valuations are:

Based on the same 6% gross yield that I used for FY2015 and FY2016, I can calculate three capitalised earnings valuations for MCY.

11.3/ (0.06 x 0.72) = $2.61 (based on averaged, normalised eps)

14.1/ (0.06 x 0.72) = $3.26 (based on averaged, normalised ordinary dps)

Now add in the 'thin air capital' potential value boost:

$2.61 x 1.1 = $2.87 (based on averaged, normalised eps)

$3.26 x 1.1 = $3.59 (based on averaged, normalised ordinary dps)


Summary:

I value MCY as worth between $2.87 and $3.59 (ex-dividend). At $3.40 on the market today, I consider MCY to be fairly valued. The real question mark is, can MCY continue to pay out more in fully imputed dividends than the core business is earning? Past declared profits have included surplus land sales and sales of surplus carbon credits which may have boosted shareholders expectations. Yet Mercury does seem to be very well run, and 'rabbits out of the hat' like high rainfall (perhaps more luck than skill!)and future interest bill savings may mean that looking at 'normalised earnings' only produces a picture that is too conservative.

SNOOPY

[Snoopy]

Snoopy you have analysed past dividends and explained a kind of creative accounting that has us all wondering how it can continue.
Contact and Genesis are basing future dividends based on free cashflow.Is this what mercury is actually doing...

Yes the policy of Mercury is to pay out 70 to 85% of free cashflow as dividends. If you look at my post 681, you see that over the last four years (the dividend period where we the public have been on the share register) 58.5cps represents 85% of free cashflows. Yet dividend payments have totalled 62.2cps(imputed) plus 4.0 cps (unimputed) , representing 96% of free cashflows. So on that basis, dividend payments from Mercury are well above the upper band of their own target payment range.

....but using special dividends to payout surplus cash in years of high profit whilst having a normal dividend that goes up more slowly-maybe in keeping with inflation and improved efficiency?

'Excuses' for paying special dividends have included money freed up from land sales and selling surplus carbon credits. However, once those particular items have been sold they are sold. There can be no repeat.

Companies do not like reducing normalised dividends. Paying a 'special dividend' means a company can 'look good' by keeping normal dividends steady in the bad times, while quietly dropping any special dividends so they can claim that 'normal dividends' are not being reduced! I think that MCY recovering from poor Waikato catchment inflows has been more of a factor that increasing efficiencies.

Remember the much trumpeted decrease in running costs since shares were available to you and I of $20m only amounts to

$20m / 1400m = 1.4cps per year (or 1cps lift in profit after tax)

SNOOPY