Brokers hike Contact on strong result

By Nick Stride

Friday 6th August 2004

A buoyant result overshadowed by ownership change has had analysts hiking their valuations of Contact Energy.

The shares closed at under $6 on Wednesday as investors digested the sale of Edison Mission Energy's 51.2% stake to Australia's Origin Energy for $5.67.

But results for the June third quarter a $41.7 million profit came in better than expected.

ABN Amro's James Miller has raised his DCF (discounted cashflow) valuation to $6.54, from $6.38.

"Given that Contact has already banked $100 million of the year's profit we would be surprised if consensus ... does not move to $148 million or slightly better," he said.

Forsyth Barr's Greg Main increased his DCF valuation to $6.47, from $6.43, on the improved outlook for retail margins over the next few years.

One feature of the better-than-expected earnings was Contact's higher hedging levels. It has almost no exposure to the spot electricity price. Another was the benefit of retail power price hikes.

Contact is expected to further raise retail prices and its new majority owner, Origin, has already signalled increases.

"We believe catalysts that will re-rate the stock will come from the continued movement in tariffs to recover the new post-Maui gas costs, and tight control of risks and costs," ABN Amro said.

While better than expected, the quarter's result was below the $42.2 million reported a year ago, when a cold, dry winter sent wholesale prices soaring.

Wholesale electricity revenues were $131 million, compared to $323.5 million a year ago.

Chief executive Steve Barrett said hydro storage levels at the end of June stood at 148% of the historical average.

Wholesale prices were therefore expected to remain low for "the next few months."

"Looking beyond these weather-induced effects, we expect that the longer-term dynamics will predominate," Barrett said.

"Demand for electricity is growing steadily while uncertainty about future fuel and technology choices for new investment in generation mean that current total generation capacity is becoming increasingly constrained."

"In addition, we know that almost all choices for future generation will produce electricity at higher costs than in the past, putting upward pressure on electricity prices."

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