Contact Energy Limited

Company Overview: Energy generator and digital retailer, Contact Energy Limited (NZX: CEN) is involved in providing electricity, natural gas, and liquefied petroleum gas (LPG), along with broadband services. The electricity is generated via thermal, hydro, and geothermal sources. It has a market capitalization of ~$4.567 billion as on September 7, 2020.

The businesses are operated under two segments i.e. Customer segment and Generation segment.

• The Customer segment is involved in delivering, servicing and distributing energy to customers,
• The Generation segment is engaged in the business of selling electricity to the wholesale electricity market and to the Customer segment.

The Company's stations include Ohaaki, Poihipi and Te Rapa in Waikato, Te Huka and Te Mihi in Taupo Wairakei in Taupo, and Whirinaki in Hawke’s Bay along with Ahuroa and Stratford in Taranaki.

CEN Details

Investment Summary:

• Strong operational performance: CEN transformed its net loss of -$66 million in FY16 into a net profit of $345 million in FY19, while the slowdown witnessed in FY20 resulted into a net profit of $125million. However, the company experienced an improvement in gross and EBITDA margins on a y-o-y basis in FY20.
• Consistent Dividend Payout: The Board of Directors declared a final ordinary dividend of 23 cents per share to be paid on 15 September 2020, representing a payout of 97% of operating free cash flow in FY20 up from 54% in FY16.
• Rising contribution from Geothermal Generation: Geo-thermal generation volumes are up significantly 42% from 2,332 GWh in FY14 to 3,333 in FY20. The world-class geothermal resource at Tauhara is expected to drive the sales in the upcoming years.
• Decarbonization Driving the Demand: CEN recently acquired 100% interest in Simply Energy which is expected to play crucial role in decarbonization process. The company signed a 13 MW renewable agreement to cater to growing decarbonization-driven demand. 
• Valuation Upside: P/CF multiple based relative valuation approach is indicating a decent upside (in % terms) on the current stock price of NZ$6.36 per share.
• Key Risks: CEN is exposed to various financial risks like market risk, liquidity risk and credit risk.
• Management of Risks: Navigated risks relating to constrained natural gas supply via a reduction in fixed priced electricity sales and prudent management of gas and hydro storage.

Historical Performance: Looking at the past performance over FY16 to FY20, the bottom-line of the company improved from -$66.0 million in FY16 to $125 million in FY20.

Despite remaining resilient through COVID-19 lockdown, the company’s profit from continuing operations for FY20 was down 26 percent to $125 million. However, the company delivered investors a 39 cents per share annual dividend this year which is in line with last year and, which can be attributed to CEN’s operational efficiency, continued strength of its balance sheet and high quality and flexible portfolio of gas-fired and renewable generation assets.

 Historical Performance (Source: Company Reports)

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 20.68% of the total shareholding. Accident Compensation Corporation and The Vanguard Group, Inc. are holding maximum stake in the company at 5.54% and 5.00%, respectively, as provided in the table below:

Top 10 Shareholders (Source: Refinitiv (Thomson Reuters))

A Quick Look at Key Metrics: Its gross margin and EBITDA margin for FY20 stood at 31.0% and 21.5%, better than the FY19 result of 28.4% and 20.3%, respectively, implying an improvement in operating efficiency of the company over the previous year. Its Debt to Equity ratio for FY20 stood at 0.46x, lower than the industry median of 0.51x, depicting a reasonable leverage position of the company.

Key Metrics (Source: Refinitiv (Thomson Reuters))

July 2020 Operational Performance:

• Under the Customer business, Mass market electricity and gas sales stood at 499 GWh as compared to 478 GWh in the previous corresponding period (pcp), and Mass market electricity and gas netback stood at $101.96/MWh as compared to $91.75/MWh in pcp.
• Under the Wholesale business, contracted wholesale electricity sales, including that sold to the Customer business, was reported at 795 GWh as compared to 790 GWh in pcp;
• Electricity and steam net revenue stood at $103.31/MWh as compared to $91.80/MWh in pcp;
• Electricity generated (or acquired) stood at 877 GWh as compared to 878 GWh in pcp.
• The unit generation cost, which includes acquired generation was reported at $40.09/MWh, as compared to $35.00/MWh in pcp.

July 2020 Operational Data Metrics (Source: Company Reports)

As on August 10, 2020, South Island controlled storage was 73% of mean, as compared to 72% as on July 30, 2020. North Island controlled storage was 59% of mean, as compared to 70% as on July 30, 2020. Total Clutha scheme storage (including uncontrolled storage) was 89% of mean. Inflows into Contact’s Clutha catchment for July 2020 were 122% of mean.

Data on Electricity Demand (Source: Company Reports)

Subdued FY20 Financial Performance: The company reported that its profit from continuing operations for FY20 (ended June 30, 2020) declined by 26% to $125 million. EBITDAF from continuing operations stood at $451 million, a decline of 11% on the previous year, mainly due to the impact of rising costs of thermal generation and restricted gas supply, along with lower renewable generation, lower wholesale prices. CEN’s operating free cash flow for FY20 stood at $290 million, a decline of 15% on the previous year, mainly due to a combination of lower operating earnings, offset by lower stay-in-business capital expenditure and interest costs.

FY20 Key Metrics (Source: Company Reports)

A Look at Recent Updates:

• CEN Acquires 100% Stake in Simply Energy: On August 10, 2020, CEN announced that it would be taking full ownership of Simply Energy. The company is currently executing various mitigation options to help move renewable electricity generation in the lower South Island North through the National Transmission Network and it is also working with commercial and industrial customers to deliver reductions to their carbon footprints by connecting them with low-carbon, reliable electricity.
• Leadership Changes: The company, on August 10, 2020, through media release made it public that there were changes to the leadership team in FY20, following the appointment of Mike Fuge as new CEO and Jan Bibby as CPO.

What to Expect: The company is disappointed by NZAS exit; however, it believes that the more investment in the utility sector would be crucial to optimize the operations. Its operation at Tauhara has been put on hold but it expects that it will play an important role in New Zealand’s transition to a low-carbon future. The following table provides an idea about the guidance provided by the company:

FY 2020 Guidance (Source: Company Reports)

Key Risks: The company is exposed to certain financial risks like market risk, liquidity risk as well as credit risk. The exit of NZAS from New Zealand poses good risk of uncertainty of reduction in demand and, therefore, leading to shrinkage in margins. The company feels the best way to mitigate the challenge is to optimize the operation and promote awareness towards utilizing of green energy.

Key Valuation Metrics (Source: Refinitiv (Thomson Reuters))

Valuation Methodology: Price to Cash Flow Multiple Based Relative Valuation (Illustrative)

Price to Cash Flow Multiple Based Relative Valuation (Source:  Refinitiv (Thomson Reuters))

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Technical Overview:

Weekly Chart -

Source: Refinitiv (Thomson Reuters)

Note: Purple colour lines are Bollinger Bands with the upper band suggesting overbought status while the lower band oversold status, and yellow lines are Fibonacci retracement lines which measure price rebound and backtrack.

The stock has been trading above 20 periods SMA for the past few weeks, and continuing with the existing trend, it has given a stronger close at a peak price of $6.36 on the first trading day for the on-going week, reflecting strength in uptrend. The technical indicator RSI with around 51 and curve at the end, pointing up, suggests bullish momentum for the stock.

Going forward, the stock may have resistance around 61.8% retracement level of $7.34 whereas support could be around 20 periods SMA of $6.17.

Stock Recommendation: The company is accelerating its mitigation plans to minimize the financial impact from the effect of Covid-19 and the exit of NZAS. Its portfolio of long-life renewable generation assets, flexible thermal assets and fuel contracts, and a strong balance sheet places the company in a comfortable position even in a lower demand environment.

Considering the aforesaid facts, recent update and FY20 results, we have valued the stock using P/CF multiple based relative valuation (on an illustrative basis) and we have arrived at a target price of lower double-digit growth (in % terms). For the valuation, we have taken peers like Genesis Energy Ltd (NZX: GNE), Meridian Energy Ltd (NZX: MEL), Vector Ltd (NZX: VCT), Mercury NZ Ltd (NZX: MCY), and Infratil Ltd (NZX: IFT).

Hence, we give a “Buy” recommendation on the stock at the current market price of NZ$6.36 per share, up by 0.47% on September 7, 2020.

CEN Daily Technical Chart (Source: Refinitiv (Thomson Reuters))

Disclaimer

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