MCY Mercury NZ ( MRP Mighty River Power)

[Snoopy]

Current dividend (incl special) of 15.139cents (incl imp crs) and assuming they match last March's dividend of 7.778cents I calculate a before tax yield of 9.2% based on a purchase price of $2.50.

I guess I need you to tell me if this is sustainable.

In general a 'special dividend' is not sustainable. If it were, it would be part of the regular dividend. The last five years is IMO the best yardstick we have of what the potential for regular income might be. This includes good and bad years and is, in my view, a better way of looking at things than trying to guess what weather conditions will be like "next year". The eps record is as follows:

Year	eps (normalised)
2011	11.5c
2012	10.8c
2013	12.0c
2014	13.3c
2015	11.1c

I get an average of 11.74cps. Buying on a 6% gross yield that I regard as 'about right' given current interest settings and a low to no growth demand environment gives an implied share price of:

11.74/ (0.06 x 0.72) = $2.72

I note the current trading price is $2.77. So even if the current dividend yield is sustainable, I don't believe the share price is cum an 8.4c final dividend combined with 2.5c special (ex dividend price is an implied $2.66).

SNOOPY

[Aaron]

In general a 'special dividend' is not sustainable.
11.74/ (0.06 x 0.72) = $2.72
SNOOPY

Two years in a row for special dividends hopefully it is becoming the norm.
Using a capitalisation rate of 6% for Gentailers, what is your current cap rate for property trusts. (although I read somewhere you don't invest in them as your house is considered your property in your portfolio)
How do you establish a cap rate and does it just move up in line with interest rate rises so in theory if interest rates rise you write down the value of your investments. 6% is OK from savings but if I am borrowing to invest with a 7% interest rate my cap rate should be at least 10% I suppose. All guess work... I guess.

[Snoopy]

Two years in a row for special dividends hopefully it is becoming the norm.

By booking tax credits from an associated $500m asset revaluation, they certainly have the capacity to pay more special dividends in FY2016, whether or not they choose to do so.

Using a capitalisation rate of 6% for Gentailers, what is your current cap rate for property trusts. (although I read somewhere you don't invest in them as your house is considered your property in your portfolio)

It would depend on the property company. With AIA, I might still go for 6%. Something like Kiwi Income Property, with a lot of mall exposure. Maybe 7.5%. Something that was more office towers, maybe 9%. But as you noted, I don't own any listed property investments.

How do you establish a cap rate and does it just move up in line with interest rate rises so in theory if interest rates rise you write down the value of your investments.

All else remaining equal, yes a rise in interest rates would cause my fair value of my high yield income producing assets to head south. But for an income investment I have a lot of confidence in, I would still be looking for a gross yield around 2 percentage points more than if I had put that same money in the bank.

6% is OK from savings but if I am borrowing to invest with a 7% interest rate my cap rate should be at least 10% I suppose. All guess work... I guess.

You are playing quite a dangerous game borrowing to invest in these high yielding shares I think. The reason is that the directors already have a fiducary duty to shareholders to pay out excess capital. So by borrowing you are in effect saying that you know better than the directors and they should be paying out more to you. It's a big call to make.

SNOOPY

[Snoopy]

In general a 'special dividend' is not sustainable. If it were, it would be part of the regular dividend. The last five years is IMO the best yardstick we have of what the potential for regular income might be. This includes good and bad years and is, in my view, a better way of looking at things than trying to guess what weather conditions will be like "next year". The eps record is as follows:

Year	eps (normalised)
2011	11.5c
2012	10.8c
2013	12.0c
2014	13.3c
2015	11.1c

I get an average of 11.74cps. Buying on a 6% gross yield that I regard as 'about right' given current interest settings and a low to no growth demand environment gives an implied share price of:

11.74/ (0.06 x 0.72) = $2.72

I note the current trading price is $2.77. So even if the current dividend yield is sustainable, I don't believe the share price is cum an 8.4c final dividend combined with 2.5c special (ex dividend price is an implied $2.66).

As of last year I am using FY2011 as the first year that Mercury 'back then' resembles Mercury today. FY2011 was the first year for the giant "Nga Awa Paroa" (128MW) geothermal station being on line. "Nga Awa Paroa" virtually doubled the geothermal generation capacity of Mercury at the time. It was also the first year that the new HVDC north south cable link was completed. So I have chosen FY2011 as the first year in Mercury's 'modern' power generation era for modelling purposes.

Year	eps (normalised)	dps (ordinary)	dps (special)
2011	11.5c	6.79c	0c
2012	10.8c	8.60c	0c
2013	12.0c	8.01c	0c
2014	13.3c	12.4c	0c
2015	10.1c	13.9c	5.0c
2016	11.1c	14.1c	2.5c
Total	68.0c	63.9c	71.4c
Average	11.5c	10.6c	11.9c
			(Total and Average of Normal+Special)

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

11.5/ (0.06 x 0.72) = $2.66 (based on averaged, normalised eps)

10.6/ (0.06 x 0.72) = $2.45 (based on averaged, normalised ordinary dps)

11.9/ (0.06 x 0.72) = $2.75 (based on averaged, normalised total dps)

This year I am calculating all three valuations, because I wanted to show there is no one 'right answer'. The 'right answer' depends what you want to look at. My preferred answer is $2.66. That calculation assumes that 100% of cumulative earnings will eventually be paid out as dividends. This is what we shareholders have observed has happened. This answer is no more 'valid' than the $2.45 valuation, based only on the ordinary dividends that have actually been paid.

There is an extra 'hidden value' contained within MRP though. This hidden value is aligned with the 'thin air capital' that Mercury creates, and that I have referred to in previous posts. One argument is that Mercury delivers the extra value of this 'thin air capital' via special dividends to optimize the capital structure of the company. If you agree with that proposition, then you can make a case for the company being worth the third higher $2.75 valuation. Personally I prefer to see the value of this 'thin air capital' reflected in a different way.

SNOOPY

[Snoopy]

Year	eps (normalised)	dps (ordinary)	dps (special)
2015	10.1c	13.9c	5.0c
2016	11.1c	14.1c	2.5c

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

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

10.6/ (0.06 x 0.72) = $2.45 (based on averaged, normalised ordinary dps)

11.9/ (0.06 x 0.72) = $2.75 (based on averaged, normalised total dps)

This year I am calculating all three valuations, because I wanted to show there is no one 'right answer'. The 'right answer' depends what you want to look at.

Eagle eyed readers will have noticed that I changed my 'normalised earnings' number for FY2015 in FY2016 (down from 11.1c to 10.1c), verses the earnings I quoted in FY2015 for FY2015. There is always some judgement involved deciding what part of the profit is 'normal' and what is 'not normal'. Reading the Annual Report for FY2016 (Note 3), I became aware that non-core property sale profits of $17m (FY2015) and $13m (FY2016) were included in the EBITDAF profit figures for the year. This is confirmed by slide 35 of the annual results presentation. Here it states that no further land sales are forecast to contribute to EBITDAF in FY2017.

I think it is disappointing that when contriving EBITDAF, to assess the 'normal' cashflow of the company, Mighty River has decided to include surplus land sales as part of 'normal'. This is IMO distortionary if you are trying to form a view of the company's 'normal' (power generation) operations.

Counter to this we learn that there was an extra $18m worth of capital expenditure, not included in the $72m of capital expenditure for FY2016 declared as such. This extra CAPEX was related to remediation of some land in relation to an investment already exited in Chile. Should I count that as 'normal'?

SNOOPY