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Morningstar | Weather Hurts Contact Again in FY18; No Change to FVE

Narrow-moat-rated Contact Energy’s fiscal 2018 result was largely in line with expectations, given good monthly disclosure. EBITDA slipped 4% to NZD 481 million, and underlying net profit fell 8% to NZD 130 million. The dry spell that marred the second half of fiscal 2017 continued into fiscal 2018 before rainfall improved in recent months. With storage levels still well below average, we expect headwinds in hydro generation to persist in the short term. However, as weather conditions normalise, we forecast improved hydro generation in the next couple of years helping to offset the impact of asset sales on earnings. Last trading at NZD 5.72 per share, Contact appears slightly undervalued compared with our unchanged fair value estimate of NZD 6.20 per share.

Following dismal hydrology conditions in the first half, generation EBITDA fell 3% to NZD 372 million. Hydro generation ended fiscal 2018 2.3% lower at 3,479 gigawatt-hours, or GWh. With geothermal generation of 3,323 GWh and a further 1,812 GWh from gas-fired peakers, total generation in fiscal 2018 increased 0.9% year on year. Nonetheless, earnings fell because the increased reliance on gas-fired power pushed operating costs higher. Total Clutha scheme storage currently sits at 70% of average, indicating headwinds are likely to persist in the near term. However, we expect gradual improvement in hydrology conditions over the next two years as weather conditions normalise, leading to a return to long-run average hydroelectric generation of 3,900 GWh from fiscal 2021.

Meanwhile, competitive pressures persist in the retail division. Despite reducing cost to serve by 12%, EBITDA in the retail division fell 8% to NZD 109 million as volumes in both mass-market and commercial and industrial fell.

We expect retail conditions to remain difficult, as competition from both the major incumbents and pure-play retailers keep downward pressure on retail prices over the medium term. However, we expect a more rational retail environment over the longer term.

Contact declared a final dividend of NZD 0.19 per share, increasing total dividends for fiscal 2018 by 23% to NZD 0.32 per share, fully imputed for New Zealand investors. Net debt/EBITDA climbed to nearly 3.1 times, higher than the firm’s target of below 2.8 times. However, the sales of the Ahuroa gas storage facility for NZD 200 million and the Rockgas LPG business for NZD 260 million should reduce fiscal 2019 net debt/EBITDA to nearly 2 times--comfortably below target leverage and supporting ongoing dividend increases. Contact guided to dividends of NZD 0.35 in fiscal 2019, slightly below our prior expectations.