EUR 850.00 For Business Accounts Only

Morningstar | Shocking Court Decision Forces Spark to Reduce Distributions

The Federal Court has sided with the Australian tax office and decided Victoria Power Networks (49% owned by Spark) must pay tax on customer contributions. This controversial decision will impact the entire industry, including Spark’s other assets, unless successfully appealed. We have long maintained earnings from customer contributions are an accounting quirk and do not represent real earnings, so are surprised with this decision.

The unfavourable court decision caused Spark to downgrade 2019 distribution guidance 8% to AUD 0.15 per security. We downgrade distributions in subsequent years by similar amounts, and increase our tax forecasts. Guidance is for a 2019 effective tax rate of 6% on standalone pretax net operating cashflows, rising to between 12% and 20% within a couple of years. While distributions fall, Australian securityholders shouldn’t be much worse off as franking credits will increase. The full-year results, to be announced on Feb. 26, should provide more clarity. We maintain our AUD 2.40 per security fair value estimate and no-moat rating for Spark. At current prices around 2.33, the stock is roughly fairly valued.

An example of a customer contribution is where a large property developer pays a utility to move a power line so it doesn’t interfere with its development project. Accounting standards see the utility recognise money received to move the line as revenue, but it doesn’t recognise the cost to build it on the income statement. Rather, the build cost is captured on the cash flow statement as capital expenditure, resulting in an increase in the book value of assets. We think this is illogical as the power line is not really worth more than it used to be, it’s just been relocated. With little or no cost recognised on the income statement, the perverse outcome is that accounting earnings are artificially boosted by practically the entire amount of the build cost, and now utilities will have to pay tax on this questionable profit.

In addition, Spark will write down the value of its investment in South Australia Power Networks by AUD 270 million at the upcoming 2018 results, to reflect the above court loss and other unfavourable regulatory changes since the asset was last valued. This is just a noncash charge.