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Contact Energy is a vertically integrated electricity generator and retailer in New Zealand. In essence, they produce electricity from their portfolio of generation assets and then sell it to end customers such as households and businesses.
From an investment point of view, the New Zealand electricity industry can be considered as far more predictable and future-proof than that of most countries and certainly that of Australia.
New Zealand generates approximately 80% of its electricity from renewable sources and in the next decade renewables could provide up to 90% of total electricity, therefore, New Zealand is already at a level of renewable generation that most nations couldn’t even aspire to. Environmental considerations aside, the key advantage for an investor is that this leads to a settled and predictable regulatory environment.
The New Zealand industry operates free from any subsidies and their power prices more accurately reflect the balance between generation capacity and overall demand, which means that there is very little incentive for disruptive behaviour whether through overbuilding of new generation or overly aggressive competition for retail clients. Instead, the entire industry is incentivised to optimise performance through efficiencies, whether by running their generation fleet better or lowering costs in their retail operations.
Equally, there is broad recognition by politicians that New Zealand’s electricity industry is efficient and does not make excessive returns meaning that, unlike in Australia, there is no call for price caps or other regulatory intervention.
Whilst Contact Energy’s share price has performed strongly of late, it still offers good value with a PE of 17.8x for FY19 (lowest in the sector) and a leading dividend yield of 5.8%.
We are invested in Contact Energy for the following reasons:
- Dividend Yield: After several years of a lower than peer group dividend payout ratio (necessary to reduce debt to an acceptable level), Contact Energy now has one of the highest dividend yields
- Reduced unit costs: An expensive and disruptive systems implementation (SAP) is now behind the Company and it is now benefiting from being better able to reduce costs in its retail division than any of its peers.
- Portfolio: The Company owns a substantial portfolio of physical generation assets that are impossible to replicate.
- Balance sheet: Contact Energy has a strong balance sheet, is highly cash-generative and pays a high (and increasing) dividend.
- Demand: The Company provides an essential service with demand relatively insensitive to economic conditions. It also operates in a stable regulatory environment.
This stock is currently held by our Pengana Australian Equities Income Fund.
This report has been prepared by Pengana Capital Ltd (ABN 30 103 800 568, Australian financial services license number 226566) (“Pengana”). This report does not contain any investment recommendation or investment advice and has been prepared without taking account of any person’s objectives, financial situation or needs. Therefore, before acting on the information in this report a person should consider the appropriateness of the information, having regard to their objectives, financial situation and needs.
Pengana is the issuer of units in the Pengana Australian Equities Income Fund (ARSN 098 586 586) (“the Fund”). A Product Disclosure Statement for the Fund (“PDS”) is available and can be obtained by contacting Pengana on (02) 8524 9900. A person who is considering investing in the Fund should obtain the relevant PDS and should consider the PDS carefully and consult with their financial adviser to determine whether the Fund is appropriate for them before deciding whether to invest in, or to continue to hold, units in the Fund.
The value of investments can go up and down. Past performance is not a reliable indicator of past performance.While care has been taken in the preparation of this report, Pengana makes no representation or warranty as to the accuracy, currency or completeness of any statement, data or value. To the maximum extent permitted by law, Pengana expressly disclaims any liability which may arise out of the provision to, or use by, any person of this report.