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Morningstar | Soft 1H for Genesis but 2H Is More Promising

Narrow-moat Genesis Energy reported a soft first half, with EBITDA down 1.5% to NZD 196 million as an improved retail performance was offset by planned outages at a power station and the Kupe oil and gas field. Without these outages repeating, second-half earnings should improve. Management upgraded guidance by a couple of percent to NZD 360 to 375 million, which at the midpoint represents growth of 2% on last year. We marginally upgrade our fiscal 2019 earnings forecasts and remain comfortable with our NZD 2.20 per share fair value estimate. At current prices, Genesis is overvalued. Our main concern is that 25%-30% of EBITDA comes from Kupe, which has volatile earnings and will deplete over the next decade or so.

The customer segment performed well with EBITDA increasing 10% to NZD 62 million in the half on cost reductions and growth of business and LPG sales. Digitisation of customer service continues to improve customer satisfaction and drive lower staff costs. Improved customer service, combined with ongoing takeup of the dual fuel offering, also lead to lower churn and thus lower costs to acquire and retain customers. But all competitors are driving digital adoption, which suggests most earnings gains are likely to be eroded by intense competition in time.

The more moaty wholesale segment, which includes generation, was softer this half, with EBITDA falling 2% to NZD 104 million. Gas supply constraints, low water storage and a planned 50-day outage of one of the Huntly generation units for maintenance caused generation volumes to fall 12%, meaning Genesis couldn’t capitalise on sharply higher wholesale prices as much as some competitors. Management remains cautious on the gas supply outlook. On the flip side, gas supply issues have pushed up electricity futures prices and should lead to higher prices for customers, a favourable environment for the “gentailers.” Overall, the outlook is good as modest underlying demand growth continues to tighten the market.

Kupe EBITDA fell 5% to NZD 53 million as higher oil and LPG prices weren’t enough to offset lower gas and oil production due to planned maintenance. Besides the outage, oil production is in a downward trend because of natural field decline. Kupe is progressing plans for an upgrade to improve oil flows.

Genesis’ financial position is sound, but weaker than peers. Net debt/EBITDA was 2.9 times in December 2018, compared with closer to 2 times for most peers. Additionally, Genesis has more volatile earnings because of the oil and gas price exposure. Nonetheless, we’re comfortable with Genesis’ financial position as credit metrics should improve markedly in coming years on earnings growth and the dividend reinvestment plan.