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Morningstar | Meridian Lifts Earnings Despite Hydrology Struggles, Increasing FVE to NZD 3.20

Narrow-moat Meridian Energy reported fiscal 2018 EBITDA of NZD 666 million, up 1.4% on the previous corresponding period, or pcp, and slightly ahead of our forecast of flat earnings. Better hydrology volumes towards the end of the fiscal year have partially offset the first half's dry spell. Lake storage levels are once again above long-term averages, boding well for near-term earnings. We expect hydroelectric generation, the vast majority of Meridian's energy production, to continue to improve as weather conditions normalise. This, and likely lower transmission charges, are key drivers of medium-term earnings growth. We raise our fair value estimate 3% to NZD 3.20 per share, and at current prices, Meridian screens as fairly valued.

Wholesale division EBITDA was broadly flat at NZD 579 million, which is a good result considering the seemingly inexorable dry spell that hurt first-half fiscal 2018 generation volumes. Meridian's first-half generation volumes in New Zealand were 16% lower than the pcp but generation picked up in the last few months and finished the fiscal year just 6% down at 12,524 gigawatt hours, or GWh. Higher wholesale prices saw Meridian call on its swaption to acquire generation from Genesis to plug its hydro generation shortfall. Rainfall is improving, and lake storage in Meridian's key catchments sits above historical averages for this time of year. Waitaki is 19% (equivalent to 255 GWh) above average and Manapouri and Te Anau together are 57% (or 146 GWh) above average. We expect earnings to improve over the medium term as rainfall normalises and the firm derives the full benefit from its huge, low-cost hydroelectric assets.

Despite less than 1% nationwide demand growth, Meridian grew retail sales volumes 4% in New Zealand, lifting retail division EBITDA 5% to NZD 77 million. The segment continues to grow customer numbers, which should translate to stronger volumes moving forward. We expect the retail environment to remain competitive, keeping pressure on retail prices in the medium term. However, retail competition should eventually diminish as the higher and more volatile wholesale price hurts pure-play retailer profit margins.

The Australian segment continues its strong growth, lifting EBITDA 22% to NZD 44 million despite flat Powershop customer numbers. With the acquisition of Trustpower's Australian hydroelectric assets, effective April 2018, adding to Meridian's existing portfolio of wind farms, its Australian operations are likely to have surplus generation output, at least in the short term until customer growth picks up. This isn't a bad thing given strong wholesale prices.

The firm will pay full-year ordinary dividends of NZD 14.32 cents, 86% imputed for New Zealand shareholders, in addition to special dividends of NZD 4.88 cents, unimputed. Net debt/EBITDA increased to 2.1 times, from 1.7 times in fiscal 2017, on acquisitions. But Meridian's balance sheet is still more conservative than peers'. With growing earnings, we forecast net debt/EBITDA falls back below 1.7 times by fiscal 2021. As such, we believe it can comfortably continue paying special dividends.