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Morningstar | AusNet's First-Half Earnings Fall Marginally, but Distributions Continue to Grow

No-moat AusNet Services' first-half 2019 EBITDA, adjusted to exclude customer contributions that we don't consider real earnings, fell 4% to AUD 594 million as lower revenue at the gas and electricity distribution networks offset a stronger performance at the high-voltage electricity transmission network. The result is tracking broadly in line with our full-year expectations, and we make only minor changes to our earnings forecasts. We maintain our AUD 1.65 per security fair value estimate and consider AusNet fairly valued at current prices. Guidance is for distributions to increase 5% to 9.72 cents per security in fiscal 2019, franked to more than 40%. This represents a solid yield of 5.7% at the current price, and we believe distributions can grow a little above CPI for at least the medium term.

AusNet remains in relatively good financial health with gearing, measured as net debt/regulated and contracted asset base, of 67%. While it might appear high, we have no major concerns given the firm's highly defensive earnings. To put in perspective, AusNet's gearing is more conservative than peer Spark Infrastructure, which sat at 74% at June 30, 2018.

Putting aside likely softer earnings in fiscal 2019, the outlook for the next couple of years is relatively benign. Modest tariff increases and the cost efficiency program should lead to low- to mid-single-digit growth in distributions at least until the next regulatory reset in January 2021. Thereafter, there could be some downside as lowering utility bills is a key focus of the government. However, we gain comfort from the fact that the regulator already significantly reduced returns for networks over the past six years. We don't think much further downside can be justified, particularly if interest rates start increasing as we expect.

Earnings will also be supported by AusNet investing substantial sums to grow its regulated and unregulated networks, which should help offset any reduction in profitability of existing assets. To fiscal 2021, AusNet expects its regulated asset base to grow around 3.5% per year and its unregulated infrastructure assets to grow around 20% per year. This capital expenditure is being sensibly funded with substantial contributions from retained earnings, which should keep gearing below 70%.

In the first half, electricity distribution adjusted EBITDA fell 11% to AUD 245 million on lower bonus payments because of a deterioration in network reliability and lower metering revenue as the firm is forced to effectively hand back prior-year overearning. Good cost control softened the blow. While fiscal 2019 clearly has headwinds, we expect mid-single-digit revenue growth for the next couple of years until this asset's next regulatory reset in January 2020. Regulated asset base--one of the key drivers of long-term earnings--increased 6% to AUD 4.3 billion on elevated levels of reinvestment into the network.
The electricity transmission network reported an 8% increase in EBITDA to AUD 202 million due to higher project revenue while the ongoing cost efficiency program helped keep expenses flat. Regulated asset base increased 1.9% to AUD 3.5 billion. We expect revenue growth at this asset to average a little over 1% per year until its next regulatory reset in March 2022.

Gas distribution adjusted EBITDA fell 9% to AUD 117 million on a 9% reduction in regulated tariffs in January 2018, partly offset by cost-out initiatives. Earnings will improve next year; we expect revenue to grow around 3% per year on average until the next regulatory reset in January 2023. Regulated asset base increased 5% to AUD 1.6 billion.

The small Commercial Energy Services business reported EBITDA of AUD 31 million, flat on last year as the business continues to refocus away from providing maintenance services to third parties. The focus going forward is on building and owning unregulated transmission lines, typically connecting new wind farms to AusNet's regulated transmission network. It is connecting four new wind farms at present, helping the contracted asset base increase 18% to AUD 637 million. We don't see any problems with the business hitting management's target of AUD 1 billion in assets by fiscal 2021 given the large number of new renewable energy projects planned.