Are Government’s Initiatives Boosting Utilities Sector – 2 Stocks to Consider

Manawa Energy Limited (NZX: MNW) is one of Aotearoa New Zealand’s largest renewable electricity generators. Vital Limited (NZX: VTL) is the provider of fundamental nationwide infrastructure as well as communication services. Kalkine’s Sector Report covers the Investment Summary, Sector Overview, Financial Metrics of the companies, Risks, Outlook, Technical Analysis along with the Valuation, Target Price, and Recommendation on selected stocks.

I. Sector Landscape and Outlook

As per the Ministry of Business, Innovation and Employment (MBIE), the net generation was 10,615 GWh in December 2022 quarter totalling to 43,503 GWh for full year FY22. Where hydro generation increased by ~9.1% Y-o-Y, geothermal generation declined by ~5.2% on pcp basis. On the consumption side, where Industrial usage declined by ~3.0%, electricity consumed for commercial purpose and transport increased by ~8.5% and ~16.1%, respectively.

NZ is utilizing the system of emissions budgets to determine the pathway for 2050 targets of net zero long-lived greenhouse gas emissions and a fall in biogenic methane emissions. On 16 May 2022, the Government released NZ’s first Emissions Reduction Plan (ERP), outlining the strategies, policies as well as actions for meeting the country’s first emissions budget (covering 2022 to 2025). Meanwhile, residential consumption is expected to grow, primarily driven by electricity and natural gas use. Further, the energy consumption for transport is growing post-quarantine-free travel. NZ is committed for a target of 50% of total final energy consumption to come from renewable sources by 2035.

Annual electricity generation and consumption

As per MBIE, Hydroelectric generation has been fulfilling New Zealand’s majority of electricity needs. Currently, there's over 5,000 MW of installed hydro capacity. The majority of it is found in the South Island. Other sources of electricity are Geothermal generation, Wind generation and from the combustion of coal, oil, and gas. Around one third of New Zealand’s electricity demand comes from households and more than one third is from industrial sectors. The majority of industrial electricity demand is from the wood, pulp, paper and printing sectors and the basic metals sectors, with the Tiwai Point aluminium smelter being the largest single user of electricity in the country.

For the December quarter, out of net generation of electricity 10,615 GWh, Hydro constituted the maximum of 7,157 GWh, followed by 1,903 GWh from Geothermal. The renewable share % was 94.7% for December quarter as compared to 89.6% for the September quarter of 2022.

Exhibit 1: Trend in Renewable Share (%) in Net Energy Generation & Consumption

Data Source: This work is owned by the Ministry of Business, Innovation and Employment on behalf of the Crown which are licensed for reuse under the Creative Commons Attribution 4.0 International Licence; Chart Created by Kalkine Group

Variety of Energy Contributors

As per MBIE, overall national electricity demand declined by ~0.1% in 2021, where industrial and agriculture demand declined and on the other hand commercial and residential demand increased. The decrease in demand from the industrial sector was largely driven by a fall in demand from wood, pulp, and paper manufacturing, which fell in 2020 and remained low in 2021.

New Zealand’s renewable share of total primary energy supply (TPES) hiked to ~40.8% in 2021, up from 40.4% in 2020. Moreover, national energy consumption increased by 0.7% compared to 2020, but was still down 6.6% compared to 2019. The greatest increase in 2021 was in the transport sector.

Exhibit 2: Quarterly Trend in Major Energy Contributors to Net Generation in New Zealand

Data Source: This work is owned by the Ministry of Business, Innovation and Employment on behalf of the Crown which are licensed for reuse under the Creative Commons Attribution 4.0 International Licence; Chart Created by Kalkine Group

Index Performance:

The S&P/NZX All Utilities (Sector) Index generated a 6-month return of ~10.82% versus ~9.67% by the S&P/NZX 50 Index. Therefore, NZX All Utilities Index overperformed NZX50 Index by ~1.15% in 6 months

Exhibit 3: S&P/NZX All Utilities (Sector) vs S&P/NZX50 Index

Source: REFINITIV

Key Risks and Challenges:

The government and private players are working together to support low-carbon electricity systems, a complex collaboration of multiple technologies with strategic functions to maximize output. Further, the uncertainty over the availability of raw materials used in renewable electricity generation implies an option value associated with the choice between future non-fossil-fuel generation and fossil-fuel technologies. In line with this, the power sector is also susceptible to drastic changes in the climate suitable for energy generation. Rising water temperature, air temperature, and frequency/intensity of droughts are prospective circumstances that could impact the generation efficiency of hydropower generation and nuclear power plants.

Exhibit 4. Key Risks in Utilities Sector:

Source:- Analysis: Kalkine Group

Outlook:

During 2021, New Zealand imported more energy products than it exported making New Zealand as a net importer of energy. National energy intensity (energy use divided by gross domestic product (GDP) which tells the amount of energy required to produce each dollar of GDP) has improved by an average of ~1.5% per annum between 1990 and 2019. Energy intensity for all sectors decreased this year 2022, with the biggest decline in chemicals and metals (11.2%) as compared to 2020. Some of this reduction can be attributed to Methanex reducing its natural gas usage and producing 19% less methanol in 2021. National energy intensity decreased 4.7% in 2021 vs. 2020.

The Government is focusing on renewable energy sources to reach the target of 50% of total energy consumption coming from renewable sources by 2035. The current contribution by solar energy towards energy supply is low, making below 0.5% of electricity generation and 0.2% of final energy consumption. The construction of Christchurch Airport’s commitment of largest single solar farm - of the Kōwhai Park energy hub (400 hectares) – is expected to start its construction in early 2023 and first generation in 2025. Moreover, growing NZ’s hydrogen industry can support NZ in achieving its commitments to reduce net emissions of all greenhouse gases (except biogenic methane) to zero by the year 2050 and has the potential to help the government’s goal of touching 100% renewable electricity by the year 2030. Apart from investment in renewable generation and hydrogen production plants, there is a requirement to make deployments towards the network of refuelling stations to support the hydrogen-powered truck fleet.

Apart from the sector-specific factors, an analysis on two NZX-listed companies is provided. This report covers their insights, outlook, performance and potential as expected to be delivered in the near to medium term.

1) Manawa Energy Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZD 1.505 billion, Annual Dividend Yield (TTM)¹: 13.889%)

Business Description:

Manawa Energy Limited (NZX: MNW) is one of Aotearoa NZ’s largest independent  renewable electricity generators.

Outlook:

MNW for FY23 expects its EBITDAF to be around the top end of NZD 127.5mn to NZD 140.0mn, mainly due to 4Q trading conditions driven by solid wholesale prices and generation volumes. However, capital expenditure guidance of NZD 45mn to NZD 55mn remains unchanged. For FY24, energy sector’s outlook is expected to be favourable as compared to FY 2023, driven by current price and volume assumptions, and changes to the company’s hedge position which will increase EBITDAF by NZD 10mn to NZD 20mn.

For FY24, the company is supposed to spend NZD 65-80mn in capital expenditure and NZD 20-28mn to receive a cash proceeds from the divestment of surplus land and carbon credits.

Technical Overview:

Daily Price Chart

Technical Commentary:

On the daily chart, MNW prices are trading above the horizontal trendline support level and taking support from the trendline. Moreover, the momentum oscillator RSI (14-period) is showing a reading of ~42.719 level. However, the prices are trading below the trend-following indicators 21-period SMA, which may act as a resistance zone. An important support level for the stock is placed at NZD 4.30 while the key resistance level is placed at NZD 5.25.

Fundamental Valuation:

P/E Based Relative Valuation

Stock Recommendation

Considering the facts above, a ‘Buy’ recommendation on the stock has been provided at the closing market price of NZD 4.80 per share, down by 1.44% as of 20 April 2023.

2) Vital Limited (Recommendation: Speculative Buy, Potential Upside: Low Double-Digit) (M-Cap: NZD 12.04 million)

Business Description:

Vital Limited (NZX: VTL) is a New Zealand-based company which provides fundamental nationwide infrastructure and communication services.  It operates through three segments: Wireless Networks, Wired Networks and Others and caters sectors such as government, civil defence, emergency services, health, utilities, public transport, education, logistics & freight, agriculture, and channel partners.

Outlook:

For 1HFY23, capital expenditure stood at NZD 1.7mn, with VTL’s focus to take advantage of network optionality or partnering or channel opportunities to improve network utilisation remaining intact. The company anticipates revenue and EBITDA (adjusted) to be in between NZD 27.5-28.5mn and NZD 5.8-6.5mn, respectively for FY23. For FY24, the revenue and EBITDA (adjusted) is anticipated to be in between NZD 28.0-29.0mn and NZD 6.6-7.1mn, respectively. Also, the reset strategies of VTL represent a planned path to return to positive free cash flow, with an initial focus on debt reduction.

Technical Overview:

Daily Price Chart

Technical Commentary

On the daily chart, VTL prices are trading above the falling trendline support level and taking support from the trendline. Moreover, the momentum oscillator RSI (14-period) is showing a reading of ~51.482 level. Further, the prices are trading above the trend-following indicators 21-period SMA, which may act as a support zone. An important support level for the stock is placed at NZD 0.230 while the key resistance level is placed at NZD 0.320.

Stock Recommendation

On a TTM basis, the stock of VTL is trading at an EV/Sales multiple of 1.8x compared to the industry (Telecommunications Services) median of 2.2x, and thus seems undervalued. The company seems to be optimistic about its turnaround metrics and is aimed to achieve an appropriate rate of return on its infrastructure asset base.

Considering the facts above and undervaluation as indicated by the TTM valuation, a ‘Speculative Buy’ recommendation on the stock has been provided at the closing market price of NZD 0.290 per share as of 17 April 2023.

Markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.

Note 1: Past performance is neither an indicator nor a guarantee of future performance.

Note 2: The reference data in this report has been partly sourced from REFINITIV.

Note 3: Investment decisions should be made depending on an individual's appetite for upside potential, risks, holding duration, and any previous holdings. An 'Exit' from the stock can be considered if the Target Price mentioned as per the Valuation and or the technical levels provided has been achieved and is subject to the factors discussed above.

Note 4:  Annual Dividend Yield is on a Trailing Twelve Month (TTM¹) basis and are subject to change based on factors such as company performance, stock price changes, etc.

Technical Indicators Defined: -

Support: A level at which the stock prices tend to find support if they are falling, and a downtrend may take a pause backed by demand or buying interest. Support 1 refers to the nearby support level for the stock and if the price breaches the level, then Support 2 may act as the crucial support level for the stock.

Resistance: A level at which the stock prices tend to find resistance when they are rising, and an uptrend may take a pause due to profit booking or selling interest. Resistance 1 refers to the nearby resistance level for the stock and if the price surpasses the level, then Resistance 2 may act as the crucial resistance level for the stock.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

Disclaimer

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