QuickView: Contact Energy

Contact Energy (CEN.NZX) is one of the largest companies listed on the NZX. Now in the very final stages of a major investment cycle, CEN’s focus and investment profile is turning rapidly to yield. Major investments made to lower CEN’s operating cost base and lift its portfolio response capability are already yielding returns, but most benefits are yet to come. Consensus is seeking a 6.4% gross yield for FY13. With CEN openly considering options to return further capital to holders, yield risk lies to the upside.

Investment cycle complete, focus shifts to payback
Since 2008, CEN has led a prolonged investment programme that has seen it spend >NZ$2bn on a range of major individual investments within a strategy of increasing asset and portfolio flexibility. Completed projects have included 166MW of new geothermal capacity build, 200MW of gas-fired peaking build and NZ’s first underground gas storage facility. CEN is now at the end of its investment cycle and has indicated a focus shift towards investment payback. Going forward, we expect CEN to start realising significant operating cost benefits by displacing expensive thermal plants with low-cost, high-capacity geothermal generation and by leveraging its complementary gas storage and thermal peaking facilities to increase its thermal fuel flexibility and lower its cost base.

Sector performance to lift
The NZ electricity sector is notable for the dominance of state-owned enterprises (SOEs) in the electricity supply chain. More than 60% of NZ’s power is produced and sold by three large SOEs. All three are in the process of being partially privatised and the public offer for shares in the first has just opened, with IPOs for the two likely to take place over the next nine to 12 months. While for CEN there are risks associated with greater market performance scrutiny of the privatised SOEs, in our view these risks are more than accounted for in CEN’s metrics.

Valuation: Yield + capital upside focus
Current consensus is seeking a FY13 DPS of 23.4c p/s, implying a gross yield on its current share price of 6.4%. Forward-consensus DPS rises quickly to 32.0c p/s by FY16, lifting gross yield to 8.7%. Nearer term, CEN has stated that it is looking at options to return capital directly to shareholders. There are a number of ways it could do so, with more detail of its thinking likely to be shared with CEN’s full-year result announcement in August.

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