EUR 850.00 For Business Accounts Only

Morningstar | Meridian is Thriving in FY19; Lifting FVE to NZD 3.50

Narrow-moat-rated Meridian Energy’s earnings are tracking comfortably above last year. For the 10 months to April 2019, we estimate EBITDA is up a high-teens percentage on the previous corresponding period. While part of the improved performance is due to increased rainfall, which we don’t overly focus on, Meridian is pushing through electricity price increases to large customers. We expect this to continue, leading us to upgrade medium-term forecasts. We increase our fair value estimate 9% to NZD 3.50. At current prices around NZD 4.40, the stock is overvalued.

In contrast to the past couple of years, the South Island is experiencing above average rainfall in fiscal 2019 while the North Island has been drier than usual. Underwhelming inflows to North Island catchments combined with gas supply issues pushed wholesale electricity prices higher, while major South Island generators such as Meridian have been producing copious amounts of low-cost hydroelectricity. This is the perfect mix for maximising earnings. Meridian’s hydro generation in the fiscal year to date is tracking 10.7% above the prior corresponding period. On May 10, North Island storage sat at just 61% of historical average for this time of year, while South Island storage was 113%. This suggests favourable conditions will continue. However, we don’t worry too much about variable rainfall. Our valuation is based on long-term rainfall averages.

Another positive for earnings this fiscal year is that high wholesale prices allowed Meridian to exercise its option with Genesis Energy profitably. Meridian contracts with Genesis for the right to buy electricity at a fixed price from the flexible gas and coal-fired Huntly power station. Being 100% renewable, this is a risk mitigation strategy to protect Meridian in dry years, when it doesn’t produce enough power to supply its customers. But it can also provide extra profit when wholesale prices are high.

So far in fiscal 2019, Meridian has bought 1,678 gigawatt hours of electricity from Genesis, adding 15% to its own generation. This electricity was bought for NZD 68 per GWh and sold on wholesale markets for NZD 142 per GWh on average, netting a tidy profit of NZD 124 million for Meridian using someone else’s power station.

What is more important to our valuation is that Meridian is having substantial success increasing electricity prices for large customers. Meridian produces far more electricity than needed to satisfy its retail customer base. It sells the excess to large commercial and industrial customers on multiyear contracts. These contracts were struck at cheap prices in prior years because of the oversupplied electricity market and depressed wholesale prices. But with the recent tightening of the electricity market, Meridian is now able to demand higher prices, and this will have a noticeable impact on overall profitability.

Wholesale volumes rose 7% in the fiscal year to date, partly on increased demand from the aluminium smelter, and the average contracted sales price rose 16.7%. We forecast wholesale volumes dip next year as rainfall and hydroelectric output normalises, but prices should keep rising at a solid rate for a couple more years.

The electricity market tightened in recent years following closure of old gas-fired power stations. Modest demand growth is also helping; nationwide electricity demand in the 12 months to May 2019 was up 0.8% on the prior 12 months.

Meridian has also done well to increase retail electricity sales. Residential and small and medium sized business sales volumes increased 2.4% in the financial year to date, more than offsetting the 0.3% fall in average prices. Meridian is setting retail prices aggressively to win market share, with customer connections increasing 4.3% in the past year. This strategy makes sense as retail customers are higher margin than wholesale customers.