Retail electricity margins unsustainably high, broker says

Electricity companies' margins on retail electricity tariffs are unsustainably high and will spur ongoing competition in the sector, to the detriment of companies like Genesis Energy, which is heavily skewed towards a residential customer base, says a new report on listed New Zealand electricity stocks by Grant Swanepoel at Craigs Investment Partners, a local arm of Deutsche Bank.

While profit margins for electricity sales for commercial and industrial customers have been squeezed and may be about to start recovering, Swanepoel calculates the $5 per MWh "netback margin" gap between residential and commercial consumers that prevailed in March 2013 has blown out to a difference of $18 per MWh.

"The bigger the gap between the segments, the bigger the opportunity for independent retailers to attack the residential market," says the report, which notes there are now 14 competitors operating in the electricity market, including the traditional "big five" of Contact, Meridian, Genesis, Mercury (owned by MightyRiverPower [NZX: MRP]), and TrustPower, with another five waiting in the wings and a new wholesale market offering, Flick Electric, newly launched.

"Over the near term", Craigs believes the inflation-adjusted price of electricity to residential consumers will fall, with recovery not likely until the 2018 financial year or beyond.

That has prompted Craigs to put 'sell' recommendations on residential customer-heavy players Genesis and MRP, while retaining 'buy' recommendation only for Contact Energy, which it says is more exposed to the commercial and industrial segment of the market and is becoming influential in establishing new, higher benchmarks for wholesale electricity prices as it makes less and less use of gas-fired power stations because of the high proportion of renewable energy now in the New Zealand electricity system. TrustPower and Meridian are reduced from a 'buy' to a 'hold' recommendation.

"We believe C&I (commercial and industrial pricing) is mostly already prepriced and will be waiting for a recovery."

Its enthusiasm for Contact is despite the company having a poor start to the year and its 'sell' posting on Genesis is despite the company bucking the trend of downward pressure on retail tariffs, having worked in recent times to raise its below-market tariffs to market norms.

The report raises target prices for four of the big five, with Genesis the only stock where it reduces its target share price from $2.19 to $2.08. The stock is down 1.3 percent today at $2.07.

Craigs raises its target for Contact to $6.69 from $6.48, compared with $6.32 today, up 0.3 percent. Meridian instalment receipts are trading this afternoon at $1.68, down 0.6 percent, although Craigs raise their target share price to $1.75 from $1.65.

It picks $2.97 as a target for MRP, up from $2.86 previously and comparing with $2.93 today, a 1.4 percent slide from yesterday's closing price.

TrustPower's target increases from $7.96 to $8.07. The stock last traded at $7.60.

The biggest threat to the sector is the potential for the Tiwai Point aluminium smelter to close suddenly, with the first possible date for that being Jan. 1, 2017, if triggered by an announcement 18 months out, on July 1 next year.

"If Tiwai were to shut we would expect discounted cashflow values to fall on average by 10 to 15 percent and share prices to collapse by over 20 percent before recovering," says Swanepoel. Genesis would be worst-affected, because it would lose opportunities to run coal and gas-fired plant since Meridian would have 572 Megawatts of installed hydro capacity that it would release into the market, making it the biggest beneficiary of a smelter closure.

However, Craigs is only expecting a reduction in production at the smelter from 2017, rather than a full shutdown.

(BusinessDesk)