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Trustpower cut to 'underperform' by First NZ on prospect of normal rainfall, skinnier margins

Wednesday 16th May 2018

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Trustpower got a mixed review from research analysts, with First New Zealand Capital downgrading the stock to 'underperform' as above-normal rainfall slows and retail margins shrink, while rival Morningstar affirmed its view that multiproduct offering will boost revenue. 

Tauranga-based Trustpower this week lifted annual profit 35 percent as the electricity gentailer's earnings were bolstered by favourable hydro generation and its retail strategy of bundling gas and telecommunications services with its electricity connections. 

However, easing rainfall is among the reasons FNZC analyst Nevill Gluyas lowered his rating. "Mean hydro reversion, sale of GSP (Green State Power) and whittling down of ACOT (avoided cost of transmission), all press the reset button on this year," he wrote. Australian Green State Power was sold for A$168 million in March 29.  

Regarding ACOT, Gluyas said in a note to clients that his valuation includes an eventual 33 percent-to-50 percent decline in ACOT revenue. In December 2016, the Electricity Authority decided that distributed generation that doesn't efficiently defer or reduce grid costs will no longer receive ACOT payments.

The EA is now "progressively whittling down the approved distributed generation list eligible for ACOT on a region by region basis," said Gluyas. Once complete the EA has estimated an overall reduction of all generator ACOT payments between $25 million a year and $35 million a year. While more recent experience suggests the reductions may be less severe "we expect TPW will bear a large proportion of this reduction," said Gluyas. 

Trustpower has said it expects a $4 million reduction in the current financial year and "we assume an ultimate 42 percent reduction by the end of FY21," said Gluyas. 

On the retail front, Gluyas said the valuation "hinges on the market’s view for future retail margins. Our view expects a sector convergence to lower margin levels."

Morningstar also expects rainfall to normalise but said the company's near-term revenue growth will be mainly driven by further traction of the retail business and its multiproduct offering and retained a three-star rating out of five, or 'hold' recommendation. 

The research house also said Trustpower has a "narrow economic moat", underpinned by its low-cost hydro-electric assets and the efficiently scaled electricity market. According to Morningstar, an economic moat is a structural feature that allows a firm to sustain excess profits over a long period of time. "Without a moat, profits are more susceptible to competition," it said. 

"Companies with a narrow moat are those we believe are more likely than not to achieve normalised excess returns for at least the next 10 years," it said. 

Trustpower last traded at $5.90 and has fallen 1.3 percent so far this year. Morningstar said the shares are fairly valued while First NZ Capital has a 12-month target price of $5.45. 

(BusinessDesk)

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