Eco Investor February 2016

Core Securities

Steady ASX Listing for Contact Energy

When it comes to renewable energy, New Zealand keeps giving with the latest instalment being the dual-listing on the ASX of Contact Energy. The listing was announced in early August last year when Origin Energy said it was selling all of its 389 million shares in Contact Energy, and the listing occured on 24 September with the shares opening at $4.40. The shares have kept their value, trading between $4.95 and $4.18 and most recently at around their opening price of $4.40.

Contact Energy is one of the biggest companies on the New Zealand Stock Exchange with a capitalization of NZ$3.3 billion. It is one of New Zealand's big five utilities and the second largest by generation capacity and retail market share.

The separation from Origin Energy was good for environmental investors as Contact Energy's environmental credentials are much higher. It generates 76 per cent of its energy from renewable sources and the balance from gas. In 2014-15, 43 per cent of its generation was hydro energy, 32 per cent was geothermal energy, and 24 per cent from gas.

Contact owns five geothermal power stations, two hydro power stations, three gas powered stations, a diesel/ gas powered station and the Ahuroa gas storage facility.


Above: Contact Energy’s generation by energy type.

Below: Contact Energy’s greenhouse gas emissions.

It also has a pipeline of gas peaking developments if these are ever needed. However, its combined-cycle gas-fired power stations were only used at 24 per cent of their capacity in 2014-15. Gas generation is more expensive and adds to Contact's cost of energy, so its main role is to balance the unreliability of hydro and wind by all market participants. The Ahuroa storage facility keeps the costs of gas generation lower than it would be.

76 per cent of energy from renewable sources means Contact is not quite as attractive as the other two New Zealand utilities on the ASX. Both Meridian Energy and Mighty River Power generate 100 per cent of their energy from renewables - hydro and wind for Meridian and hydro and geothermal for Mighty River Power. But 76 per cent renewables and the balance gas ain't bad and it is much more attractive than Australia's listed utilities.

Contact also retails electricity, gas and LPG products and services to residential, small business, commercial and industrial customers. The natural gas and LPG are a small part of this business.

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Above: Contact Energy’s Generation Assets.

Below: Contact's Te Mihi geothermal power station.

In terms of its commitment to be environmental, Contact says it manages its impact on the natural environment by complying with 220 resource consents across its sites.

Chief executive officer, Dennis Barnes said "Water quality and access, and biodiversity continue to be high priorities for us as the ongoing competing interests and values of water and ecosystems hold centre stage for New Zealand. Contact is working on developing a strategy for how we will care for and manage these resources which are critical to the sustainability of our business."

Its programs include water management; native fish management; native habitat, vegetation and wetland restoration; and weed removal and control.

In 2014 Contact reduced its Emissions Trading Scheme (ETS) obligations by 33 per cent. Most of its emissions come from gas.

The company's 2014-15 annual report was its first to use a global benchmark for sustainability reporting - the core option of the Global Reporting Initiative (GRI) G4 Sustainability Guidelines. That is also a step in the right direction.

Financials

Contact Energy's basic financials are sound but subdued. It made a profit of NZ$133 million in 2014-15 but this was down from NZ$234 million in 2013-14. Earnings per share were NZ 18.2 cents, down from NZ 32 cents.

Total assets at 30 June were NZ$6 billion and net assets NZ$3.1 billion. Total borrowings were a not insignificant NZ$1.75 billion and these were the major part of the total liabilities of NZ$2.9 billion.

Return on equity, measured as net profit divided by shareholders' equity, was only 4.2 per cent, so there is room for improvement. The return on equity in 2013-14 was 6.5 per cent. So this needs to turn around and start heading in the right direction.

Mr Barnes said the much lower 2014-15 profit was due to intense competition in the market through margin pressure in the retail electricity business, plus unfavourable movement in the fair value of financial instruments and costs from the company's Retail Transformation project.


Contact Energy’s dividend history.

On the positive side, he said an improvement in free cash flow allowed for increased distributions. Free cash flow was NZ$363 million, up NZ$64 million due to inventory movements in natural gas and favourable retail collections and this more than offset the reduction in earnings.

In May last year the board revised its dividend policy to pay an average of 100 per cent of underlying earnings after tax. 100 per cent sounds a lot and makes it look like the company has few growth options, and the company confirmed this saying it has no near-term opportunities for capital investment.

In fact in 2014-15 it gave back capital by paying a special dividend of NZ 50 cents per share on top of the normal NZ 26 cent dividend. One has to wonder how much of this was due to then majority shareholder Origin Energy's debt woes?

The company is also undertaking a share buyback program so the board must be feeling confident about its balance sheet and capital position.

So buying Contact would be for income rather than growth. The normal interim and final dividends have been stable in recent years. However, in 2014-15 the company ran out of NZ imputation credits so until this changes the headline dividend it pays is the dividend you get. The yield on the normal dividend is currently about 5.5 per cent. (ASX: CEN)

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