Contact Energy - CEN Chart

[Snoopy]

Below I present my corrected earnings picture for the last ten years. You will note that:

1/ I have deleted the FY2015 50cps special dividend from the record, because it will not be possible to repeat that into the future.
2/ The 'Scenario Dividend Per Share Column' represents a prediction of an ongoing dividend of 100% of free cash flow being paid into the foreseeable future. However, in the two years this policy has been in existence, only 39cps has been paid out. So where the 100% of operating free cashflow exceeds that figure I have capped the dividend payout to 39cps.
3/ The (A) - (B) difference column, if negative, represents the amount of the projected dividend not covered by imputation credits. This is important, because a dividend paid without imputation credits is in accounting terms, equivalent to giving shareholders their own capital back (equal to the amount of the unimputed dividend) complete with a tax bill. This is generally bad for investors. It is necessary to make a negative adjustment to account for any expected tax to be paid on the unimputed dividend component.
4/ The capital component of the dividend is the portion of shareholder equity being returned to shareholders. This will need to be removed from the dividend return calculation. Because to pay it is to return to shareholders money on the balance sheet that they already have, so it isn't a shareholder benefit.
5/ The unimputed component tax bill column, represents the income tax charged on share capital that is expected to be paid by the shareholder. A 28% tax rate is assumed. Note that if the (A)-(B) difference is positive there is no extra tax bill. That's because in such a year, the dividend is fully imputed.
6/ The final column (Column D) represents the 'effective' dividend per share adjustment for any extra tax obligation from paying tax on unimputed distributions.

Scenario Basis Financial Year	eps (A)	Scenario dps (B)	Difference (A)-(B)	Divie Capital Component (C)	Unimputed Tax Bill (D)	Difference (B)-(C)-(D)
2011	21.7c	19.0c	+2.7c	0c	0c	19.0c
2012	24.7c	38.0c	-13.3c	13.3c	3.7c	21.0c
2013	28.1c	39.0c	-10.9c	10.9c	3.1c	25.0c
2014	27.7c	39.0c	-11.3c	11.3c	3.2c	24.5c
2015	22.4c	39.0c	-16.6c	16.6c	4.6c	17.8c
2016	22.1c	39.0c	-16.9c	16.9c	4.7c	17.4c
2017	18.7c	39.0c	-20.3c	20.3c	5.7c	13.0c
2018	18.2c	39.0c	-20.8c	20.8c	5.8c	12.4c
2019	24.3c	39.0c	-14.7c	14.7c	4.1c	20.2c
2020	17.7c	39.0c	-21.3c	21.3c	6.0c	11.7c
Total	225.6c (E)	369.0c (F)				182c
Business Cycle Imputation Rate (E)/(F)		61.14%

.

The expected average dividend per year, net of tax is therefore: 182 / 10 = 18.2cps (net)

Using a tax rate of 28c this is equivalent to a gross income of: 18.2cps /(1-0.28) = 25.3c

Now we come to a critical point in this analysis - the choosing of an indicative interest rate that allows us to value Contact on the basis of being an ongoing income stream, albeit not quite a 'bond equivalent'. I have previously used a figure of 5.5%. But that was in a climate of investment interest rates of some 3.5%. Interest rates have fallen by at least 200 basis points since then. OTOH the previously unthinkable is happening in that the Tiwai Point aluminium smelter is closing, and the power market is consequently in a state of flux as to how particularly Contact will be able to extricate the consequential surplus energy from their Clutha River power stations at Clyde and Roxburgh while 'transmission north' is constrained. To balance these competing factors, I have assessed that a gross return of 4.5% iThe bulk of these tax credits came about in FY2016, because of $204m of impairments net of tax relating to the closure of the Otahuhu Power Station, an assessment that the Taheke Geothermal field is unlikely to be developed in the foreseeable future (from a June 2016 perspective) and a write down in the value of inventory gas. I have calculated above that $63m of those tax credits have been used up, which means that $97m - $63m = $34m are yet to materialise. That means there are probably two years worth of 'Superimputed dividends' for Contact Energy shareholders to come. What value of superimputation is appropriate? I am going with the average that I calculated in the first quoted post on this thread of 71.64%.s now appropriate for Contact Energy.

If we assume that a business cycle investment 'gross return' of 4.5% is required, then this equates to a CEN share price of:

25.3c /0.045 = $5.62

So $5.62 is therefore 'fair value'.

Readers should note that $5.62 represents 'business cycle neutral' fair value. We could argue that we are currently at the top of a low interest rate inspired valuation cycle. My rule of thumb would suggest a 'top of cycle' value some 20% higher than my calculated fair value.

$5.62 x 1.2 = $6.74

Contact Energy is trading at $6.25 as I write this post. This technique would suggest that Contact Energy is now 11% overvalued (above fair valuation), not unexpected given the plunge in interest rates of late is probably worrying yield investors, and not out of line with the broad overvaluation of the NZX as a whole.

But does a 'capitalised dividend valuation' give the full picture?

I have reworked my model based on just the last four years of operations.

1/ The 'Scenario 'Dividend Per Share' and 'Scenario Earnings Per Share' columns (from my post 1978) represent a prediction of an ongoing dividend of 90% of free cash flow being paid into the foreseeable future. The FY2021 forecast, under the same policy of paying out 80-100% of free cashflow, is 35cps. This is somewhat less than my four forecast scenarios where dividends range between 41cps and 47cps. However these scenarios reflect a future where Tauhara is operational which should provide an incremental boost to Contact's profitability. I also note that in the current forecast year, the proposed dividend of 35cps is a figure towards the lower end of the 80-100% cashflow payment range. I therefore do not consider the modelled dividend payout to be unrepresentatively high, once Tauhara is up and running.
2/ The (A) - (B) difference column, if negative, represents the amount of the projected dividend not covered by imputation credits. This is important, because a dividend paid without imputation credits is in accounting terms, equivalent to giving shareholders their own capital back (equal to the amount of the unimputed dividend) complete with a tax bill. This is generally bad for investors. It is necessary to make a negative adjustment to account for any expected tax to be paid on the unimputed dividend component (Column (D).
3/ The capital component of the dividend is the portion of shareholder equity being returned to shareholders. This will need to be removed from the dividend return calculation. Because to pay it is to return to shareholders money on the balance sheet that they already have, so it isn't a shareholder benefit.
4/ The unimputed component tax bill column, represents the income tax charged on share capital that is expected to be paid by the shareholder. A 28% tax rate is assumed. Note that if the (A)-(B) difference were to be positive then there would be no extra tax bill. That's because in such a year, the dividend would be 'fully imputed'.
5/ The final 'Difference Column' represents the 'effective' dividend per share, adjusted for any extra tax obligation from paying tax on unimputed distributions.

Scenario Basis Financial Year	eps (A)	Scenario dps (B)	Difference (A)-(B)	Divie Capital Component (C)	Unimputed Tax Bill (D)	Difference (B)-(C)-(D)
2017	22.2c	43.0c	-20.8c	20.8c	5.8c	16.4c
2018	21.9c	42.0c	-20.1c	20.1c	5.6c	16.3c
2019	27.3c	47.0c	-19.7c	19.7c	5.5c	21.3c
2020	21.4c	41.0c	-19.6c	19.6c	5.5c	15.9c
Total	92.8c (E)	173.0c (F)				69.9c
Business Cycle Imputation Rate (E)/(F)		53.64%

.

The expected average dividend per year, net of tax is therefore: 69.9 / 4 = 17.5cps (net)

Using a tax rate of 28c this is equivalent to a gross income of: 17.5cps /(1-0.28) = 24.3c

Now we come to a critical point in this analysis - the choosing of an indicative interest rate that allows us to value Contact on the basis of being an ongoing income stream. I have previously used a figure of 5.5%. But that was in a climate of investment interest rates of some 3.5%. Interest rates have fallen by at least 200 basis points since then. OTOH the Tiwai Point aluminium smelter is likely on a three year wind down closing path. The power market is consequently in a state of flux as whether an energy intensive replacement industry like hydrogen fuel production, will arrive. If not, there is work to be done, by Transpower, to ensure Contact will be able to extricate the consequential surplus energy from their Clutha River power stations at Clyde and Roxburgh. The 'transmission north' constraints need to be relieved. There is also uncertainty as to how Tauhara will feed into the mix of competitors' new wind farms that are due to come on line within a similar construction timeframe.

To balance these competing factors, I have assessed that a gross return of 4.5% is an acceptable return from a shareholder perspective, investing in Contact Energy's assets.

Dividends can only be imputed to the extent that tax credits are being and have been generated. The bulk of the Contact tax credits on the books came about in FY2016, because of $204m of impairments net of tax relating to the closure of the Otahuhu Power Station, an assessment that the Taheke Geothermal field is unlikely to be developed in the foreseeable future (from a June 2016 perspective) and a 'write down' in the value of inventory gas. I have calculated above that $63m of those tax credits have been used up, which means that $97m - $63m = $34m are yet to materialise. That means there are probably two years worth of 'Superimputed dividends' for Contact Energy shareholders to come. What value of superimputation is appropriate? I am going with the average that I calculated in the early part (post 1799) of this valuation exercise of 71.64% as a figure that is now appropriate for Contact Energy.

If we assume that a business cycle investment 'gross return' of 4.5% is required, then this equates to a CEN share price of:

24.3c /0.045 = $5.39

So $5.39 is therefore 'fair value'. However, this is fair value in the future, three years hence when Tauhara is up and operating. We need to discount this back using an appropriate 'time value of money' factor. This I calculated in post 1978 to be 0.8763.

0.8763 x $5.39 = $4.73

Readers should note that $4.73 represents 'business cycle neutral' fair value. We could argue that we are currently at the top of a low interest rate inspired valuation cycle. My rule of thumb would suggest a 'top of cycle' value some 20% higher than my calculated fair value.

$4.73 x 1.2 = $5.67

Contact Energy is trading at $7.49 as I write this post. This technique would suggest that Contact Energy is now 31% overvalued (above fair valuation), not unexpected given the plunge in interest rates of late is probably worrying yield investors, and not out of line with the broad overvaluation of the NZX as a whole.

But does a 'capitalised dividend valuation' give the full picture? Maybe not!

SNOOPY

[Snoopy]

Yesterday's capital raising document was the first I had heard of Contact Energy investigating building their own battery storage unit to become intergrated with their wholesale generation of power. I do wonder if anyone proof read the announcement, because batteries store energy, which means their capacity is measured in MWh (Mega Watt Hours) not MW (MegaWatts), I presume what the announcement was getting at was that the battery had to be able to supply power at the rate of 50MW. But that says nothing about how big the battery installation is proposed to be. For example a 50MWh battery could theoretically supply 50MW of power for one hour. But 50MWh would seem too small to be very useful.

Contact has a couple of very large 'hydro batteries' in the South Island, otherwise known as the Clyde and Roxburgh dams. But these dams are in the wrong island and are constrained in supply capacity by the Cook Strait cable which must be shared with Meridian. So I can see the logic of Contact building their own North Island battery. But it all goes to show how valuable the Waikato River 'hydro battery' system is, And that is owned by the opposition- Mercury Energy.

I remain puzzled by how such a relatively small grid scale battery will fit into Contact's generation asset portfolio. Is it a very expensive replacement for a gas peaker unit?

The video conference recording on the capital raising answered my question. The proposed battery would store power supplied across the cook straight cable when the cable was not fully utilised. It may only store a couple of hours worth of maximum discharge power on current costings. But the way battery costs are going, it might be more than that once the project is finished in around 2025.

Or I could have looked at Turnips post:

About the battery project, there was this commentry during the interim results webcast at 0:55:

" ... the biggest benefit of the battery is the reserves it gives you on the North Island, which allows you to run the HVDC harder and make sure all of the Tiwai volumes, or as much of the Tiwai volume as possible, gets across the Cook Strait. It is still a Tiwai mitigation and so we will do it at some point, but by delaying it, with the rapid technology curve reductions for batteries, the economics are getting better every second that we delay it "

Edit: I missed a bit, it continues "But the fact we can leverage a Tiwai mitigation to get build, own and operate experience for the first grid-scale battery in New Zealand is something that we're quite excited about.:"

That gives the text of what was actually said.

SNOOPY

[Snoopy]

The video conference recording on the capital raising answered my question.

It also clarified the "Long Run Marginal Cost Bar Graph" on slide 10. The first red bar on the left of the graph represent Tauhara. The next three bars are unnamed wind power stations, No doubt one of these is Mercury's Turitea. However Tauhara is better than it looks, because that graph only shows the cost to build per MWh that can be generated. The utilisation rate of a geothermal station is roughly twice that of a wind farm. So it can not only generate power at the lowest cost incremental rate. It can also deliver more of it.

SNOOPY

[FatTed]

Lego Man said:-For those wanting some additional background, S&P just announced a change to their weighting methodology for the underlying index that the Blackrock ETF replicates. MEL are currently around 4-5% weights in this index which has at least 6-7bn of ETF money folowing it. S&P launched a review in response to the clear observation of the effects that their buying was having on a whole lot of underlying stocks in the index.

Now, effectively the MEL and CEN weights are going to be liquidity capped after the next rebalance which will happen at the end of March. Broker estimates are for up to 500m worth of stock to be sold by Blackrock for both to make this rebalance.

The price is tanking because local fund managers and instos are getting out ahead of the ETF selling wave. MEL is getting hit more as there was already less fundamental support (lower dividend yield).

Does this mean that the share offer from CEN at a price of $7 is a little high with the rebalance due at the end of next month?

[winner69]

Does this mean that the share offer from CEN at a price of $7 is a little high with the rebalance due at the end of next month?

Quite possible

If you able to partake in the offering up to you decide whether you want more shares and then take a punt $7 is good (long term) or wait until they cheaper

Decisions

[Poet]

Surely this index rebalancing isn't as simple as it's being made out in the media - I can see a scenario where an ETF fund actually might need to buy more CEN rather than to sell

We need to take account of the actual price of the underlying share when calculating the index weighting of that share and since CEN shareprice has fallen from $10.75 to $7.11 in the last six weeks, any fund holding this share over that period would have seen the value of those CEN shares that they own fall by 35% and hence the relative weighting of CEN in that fund's index would also have fallen by the same 35%. This may mean that CEN's weighting in that ETF has already self-corrected (or even over corrected!).

Or am I misunderstanding the way these ETF make their buy/sell decisions?

[winner69]

Surely this index rebalancing isn't as simple as it's being made out in the media - I can see a scenario where an ETF fund actually might need to buy more CEN rather than to sell

We need to take account of the actual price of the underlying share when calculating the index weighting of that share and since CEN shareprice has fallen from $10.75 to $7.11 in the last six weeks, any fund holding this share over that period would have seen the value of those CEN shares that they own fall by 35% and hence the relative weighting of CEN in that fund's index would also have fallen by the same 35%. This may mean that CEN's weighting in that ETF has already self-corrected (or even over corrected!).

Or am I misunderstanding the way these ETF make their buy/sell decisions?

Might be large inflows into these two funds as well ....more MEL and CEN shares needed.

[iceman]

The reweighting about to take place at the end of March for the clean energy funds is a bit complex but they do have to reduce the weighting of both CEN & MEL. Of course the SP drop has done some of that reduction already !!
But we should not forget that with all the talk about Biden policies favouring clean energy, there could be some significant inflow of funds into these funds and if this is the case, the need to sell CEN & MEL is reduced.

Just to show the inflows, the 2 Blackrock clean energy have grown from a combined US$ 10.05 B on 31/12/20 to US$ 13.06 B on 17/02/21

[Baa_Baa]

On the chart, CEN daily SP is basing now at a historical support, the 200MA and the 61.% FIB retrace from Covid-low to the insane spike-high recently. It is and remains in a severe short term down-trend. It's concerning that this and the other 'boring' energy shares have gone from steady SP rises and healthy returns over years - to incredible capital volatility.

[Scrunch]

Surely this index rebalancing isn't as simple as it's being made out in the media - I can see a scenario where an ETF fund actually might need to buy more CEN rather than to sell

We need to take account of the actual price of the underlying share when calculating the index weighting of that share and since CEN shareprice has fallen from $10.75 to $7.11 in the last six weeks, any fund holding this share over that period would have seen the value of those CEN shares that they own fall by 35% and hence the relative weighting of CEN in that fund's index would also have fallen by the same 35%. This may mean that CEN's weighting in that ETF has already self-corrected (or even over corrected!).

Or am I misunderstanding the way these ETF make their buy/sell decisions?

I got the impression somewhere that the liquidity weightings are doing most of the adjustment. The base index is however increasing from 30 to 35 stocks. This will decrease the demand for all existing 30 stocks as part of the existing fund value is put into the 5 new index components. The effect of this will depend on how big these next 5 candidates are.