Decarbonization Effort by Government to Support NZ's Utilities Sector – 3 Stocks to Consider

This report is an updated version of the report published on 9 June 2022 at 5:15 PM (GMT +12)

I. Sector Landscape and Outlook

As per the Ministry of Business, Innovation and Employment (MBIE), technological transformation, changing consumer preferences and demands are driving the role of energy in the domestic and international market. Electric vehicles contributed 2% of the vehicle fleet by the end of 2021, and it is expected that 90% of electricity will be generated from renewable sources by 2025. As per the Ministry for the Environment, Climate Change Response Act (CCRA) targets (i) net-zero emissions of all GHG other than biogenic methane by 2050 and (ii) a 24-47% reduction below 2017 biogenic methane emissions by 2050.

Rising Trend in Renewable Share in Net Generation

As per MBIE, the renewable share in net generation grew to 90.7% in December quarter 2021 from 84.3% in December quarter 2020, primarily driven by a double-digit rise in solar energy (up 24.8%) and wind energy (up 17.9%). This growth in a net generation was also supported by the increase in hydro contribution (up 4.7%) and geothermal (up 4.4%). However, oil contribution towards net generation fell significantly (down 82.0%), followed by coal (down 28.4%). The robust rise in renewable energy in the net generation is primarily driven by government policies attributable to the common goal of clean energy. Meanwhile, the elevated Oil and Gas, as well as energy prices, are causing persistent challenges for the renewable industry, making renewables even more competitive.

Exhibit 1: Trend in Renewable Share (%) in Net Generation Since March 2018 Quarter

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

Double-Digit Fall in Total Emission in September 2021 Quarter

As per Stats.NZ, total emissions decreased 11%, 2,405 kilotonnes (kt) in the September 2021 quarter versus June 2021 quarter. This coincides with a 3.7% fall in the gross domestic product (GDP) over the same time.

Data Source: This work is based on/includes Stats NZ’s data which are licensed by Stats NZ for reuse under the Creative Commons Attribution 4.0 International Licence; table Created by Kalkine Group

Rise in Electricity Consumption in December Quarter 2021

As per MBIE, the average residential expenditure on electricity increased 4.8% YoY to $505 in December 2021, mainly driven by growth in electricity consumption per household by 1.4% YoY to 1,654 kWh for the same period. The nominal residential cost of electricity (including GST) increased by 3.3% YoY to 30.50 c/kWh, led by growth in lines component by 3.3% YoY to 11.62 c/kWh and energy & other components by 3.3% YoY to 18.88 c/kWh. This uptick in electricity consumption and pricing indicates clean energy transition, clean energy strengths, with the expansion of renewables, among other factors.

Exhibit 3: Trend in Consumption per Household Since March 2018

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 2-year return of ~23.44% versus ~-0.77% by the S&P/NZX 50 Index. Therefore, NZX All Utilities Index overperformed NZX50 Index by ~24.21% in 2-year.

Exhibit 4: S&P/NZX All Utilities (Sector) vs S&P/NZX50 Index

Source: REFINITIV

Key Risks and Challenges:

The government is working with private companies on low-carbon electricity systems that are a highly complex collaboration of different technologies with multiple functions to ensure reliable supply. Further, the uncertainty over the availability of elements used in generating electricity implies an option value associated with choosing between non-fossil-fuel generation and fossil fuel technologies in the future. The power sector is exposed to climate change like rising water temperature, air temperature, and frequency/intensity of droughts are likely to impact generation efficiency, hydropower generation and nuclear power plants.

Exhibit 5. Key Risks in Utilities Sector:

Source: Analysis by Kalkine Group

Outlook:

As per the ‘Wellbeing Budget 2022’, released in May 2022, the government is focussing on energy independence by shifting towards a low-carbon economy to support workers, businesses and communities. It has established a new Climate Emergency Response Fund. It primarily invests in decarbonizing process heat and public transport, slashing agricultural emissions, growing carbon storage, and augmenting low-emission vehicles to minimize dependency on volatile global oil and energy markets. Budget 2022 will provide $678 million to expand the Government Investment in Decarbonising Industry Fund (GIDI).

Under this plan, Southern Paprika Limited received ~$5 million to install Aotearoa New Zealand’s first CO2 recovered biomass boiler, projected to decrease ~250,000 tonnes of carbon over its life. Papakura Timber received ~$400,000 to install a wood boiler for kiln dryers which is projected to decrease ~33,000 tonnes of carbon over its life.

Apart from the sector-specific factors, we have also analysed three NZX-listed companies operating in the same sector. This report covers their insights, outlook, performance and potential as expected to be delivered in the near to medium term.

1) Mercury NZ Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$7.99 billion, Gross Dividend Yield: 4.466%)

Mercury NZ Limited (NZX: MCY) generates electricity from renewable sources. The company sells electricity through its retail brands - Mercury and GLOBUG.

Outlook

The company anticipates EBITDAF ~$570 million for FY22, factoring in Tilt Renewables and Trustpower retail acquisitions and excluding possible interim insurance payment arising from Kawerau station unplanned outage. These acquisitions are expected to diversify the revenue line and firmly position the company in the long run as the economy is heading towards decarbonisation. The capex guidance remains at $70 million for FY22, and ordinary dividend guidance remains at 20.0cps, fully imputed, indicating an 18% rise over FY21.

Valuation Methodology: EV/Sales Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation

The stock has been valued using EV/Sales multiple-based illustrative relative valuation, and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to EV/Sales Multiple (NTM) (Peer Average), considering its extensive renewable generation pipeline and the recent acquisitions that would add over 1,100GWh to its total annual generation.

Considering the aforementioned factors, we recommend a “Buy” rating on the stock at the current market price of $5.61 per share as of 9 June 2022 (New Zealand Time: 11:39 AM (GMT +12)).

2) Genesis Energy Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$2.68 billion, Gross Dividend Yield: 8.963%)

Genesis Energy Limited (NZX: GNE) is an energy company involved in generating electricity, retailing and trading energy, and developing and procuring fuel services.

Outlook

The company is enhancing its digital capabilities, new renewable generation sources, and maximising the efficiency and output of assets for future growth. The company undertook three investment projects to strengthen its footprints - at Kupe, Tekapo B, and the Waikaremoana Power Scheme. The focus will be on the Future-gen strategy by signing additional power purchase contracts for wind and geothermal generation and a joint venture contract with FRV Australia. The company has guided FY22 EBITDAF to stay between $430-$440 million, subject to hydrological conditions, gas availability, material events, one-off expense or other unforeseeable circumstances.

On 9 June 2022, the company advised that 14 October 2022 would be the departure date for CEO, Marc England.

Valuation Methodology: EV/Sales Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation

The stock has been valued using an EV/Sales multiple-based illustrative relative valuation, and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to EV/Sales Multiple (NTM) (Peer Average), considering its future growth strategies and decent outlook.

Considering the aforementioned factors, we recommend a “Buy” rating on the stock at the current market price of $2.55 per share as of 9 June 2022 (New Zealand Time: 2:09 PM (GMT +12)).

3) Manawa Energy Limited (Recommendation: Buy, Potential Upside: Low Double-Digit) (M-Cap: NZ$2.03 billion, Gross Dividend Yield: 11.715%)

Business Description:

Manawa Energy Limited (NZX: MNW) is Aotearoa, New Zealand’s largest independent electricity generator and renewables developer, with an overall installed capacity of 498MW.

Outlook

The company has over 30 new solar and wind development projects under active consideration, including four solar projects in the feasibility stage. The company expects the new generation to deliver incremental earnings in the medium term. Further, the new investments focus on capital spending and opex towards new generation projects. The company anticipates EBITDAF in the $140-$160 million range and capital expenditure to stay within the ambit of $45-$55 million for FY23.

On 8 June 2022, the company advised that its Annual Shareholders' Meeting would be held on 12 August 2022, and the closing date for director nominations would be 23 June 2022.

Valuation Methodology: EV/Sales Based Relative Valuation (Illustrative)

Technical Overview:

Daily Price Chart

Source: REFINITIV, Note: Purple color line reflects Relative Strength Index (14-Period)

Stock Recommendation:

The stock has been valued using an EV/Sales multiple-based illustrative relative valuation, and the target price so arrived reflects a rise of low double-digit (in % terms). A slight premium has been applied to EV/Sales Multiple (NTM) (Peer Average), considering the strong financial performance in FY22, as well as decent outlook.

Considering the aforementioned factors, we recommend a “Buy” rating on the stock at the current market price of $6.45 per share as of 9 June 2022 (New Zealand Time: 11:39 AM (GMT +12)).

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

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.

Technical Indicators Defined: -

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest.

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

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

Disclaimer

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