Company Overview: Spark Infrastructure Group is engaged in investment in regulated electricity distribution and transmission businesses in Australia. The Company operates through four segments: Victoria Power Networks, SA Power Networks, TransGrid and Other. Victoria Power Networks holds interest in two electricity distribution businesses in Victoria, which include CitiPower and Powercor. SA Power Networks is the operator of South Australia's electricity distribution network, supplying approximately 856,000 residential and commercial customers. TransGrid connects generators, distributors and end users in New South Wales (NSW). It holds interest in the electricity transmission business, which include NSW Electricity Networks Assets Holdings Trust (NSW Electricity Networks Assets) and NSW Electricity Networks Operations Holdings Trust (NSW Electricity Networks Operations). Other represents the economic interest in DUET Group. The Company also invests in regulated water and sewerage assets.


SKI Details

When talking about income stocks with sustainable dividends, this regulated electricity distribution and transmission group, Spark Infrastructure Group (ASX: SKI) looks to be a favorable player. The key aspect to note is that Spark has maintained its distribution guidance for CY18 (of 16.0 cents per share) with about 5% year on year growth while the distribution cash coverage reduced a bit (2017 distribution cash coverage was 104%, against 2016 level of 119%). Further, the group has guided the distribution growth to be at least CPI beyond 2018 to 2020. While investors might be worried about Spark paying cash tax soon, its key assets do have regulatory certainty until 2020, which can help reduce risks to distributions. As of now, the amount of tax and timing of payment are expected to be related to underlying performance and result of the disputes with the ATO. On the other hand, a key economic aspect is the inflation, which if remains low, can slowdown the distributions growth. Nonetheless, in terms of growth opportunities, SKI’s Transgrid is expected to capture the significant exposure in renewables and will use surplus cash to fund growth as of now. All in all, we expect the drivers like these to maintain the long-term potential intact.

Capital Management: In April, Spark announced that Victoria Power Networks (Finance) Pty Ltd (VPNF), which is the Common Funding Vehicle for Victoria Power Networks (CitiPower and Powercor), in which it holds a 49% interest, has reached an agreement with investors with regards to Norwegian and Euro Private Placements to raise approximately A$129 million for the capital works program and further refinancing requirements during the second half of 2018.Particularly, VPNF indicated to place 10 year Norwegian Kroner and 12 year Euro Private Placements, being inaugural issuances in these markets. VPNF has raised Nkr550 million of 10 year fixed rate notes while cross currency swaps were executed at the time of the note placement resulting in total proceeds of approximately A$91 million. Further, VPNF has placed €24 million of 12 year fixed rate notes for Euro private placement and cross currency swaps were executed at the time of the note placement resulting in total proceeds of approximately A$38 million. Moreover, VPNF has reached agreement with investors to place 7 and 12 year Hong Kong Dollar Private Placements and 10 Year Australian Medium Term Notes. Thus, VPNF raised HKD$517 million of 7 year fixed rate notes and HKD$320 million of 12 year fixed rate notes. Cross currency swaps were executed at the time of the note placement resulting in total proceeds of approximately A$139 million. In addition, VPNF placed $225 million of 10 year Australian medium term notes, and total proceeds raised equate to approximately A$364 million and the funds will be applied to refinance pending debt maturities in June 2018.

Delivered higher distributions to investors in FY17: SKI has reported 4.5% growth in the EBITDA of $791.5m in FY 17 on the back of the revenue growth and strong cost control. Standalone net operating cash flow in FY 17 fell 7.9% to $267.5m due to lower distributions from TransGrid. Further, in FY 17, Capex has risen 26.7% to $469.0m. Regulated and contracted asset base (RCAB) was $5,880m in 2017, which is up by 2.7%. Net debt/RCAB fell 0.7% to of 73.5%. Moreover, in FY 17, the Cash distributions from investment businesses were of $284.4m, with increased distributions from Victoria Power Networks offset, in part, by reduction in distributions from TransGrid due to higher retained cash flows to support investment in unregulated connections.
 

FY 17 Financial Performance (Source: Company Reports)

Positive Outlook: SKI has reaffirmed the distribution guidance for FY18, subject to business conditions, of 16.0 cps, which represents an annual growth of 4.9% on FY2017. The full year 2017 distribution is of 15.25 cents per security (cps), which is in line with guidance and fully cash covered at payout ratio of 95.9%. Further, SKI expects the growth in distributions per security, through to the end of the regulatory determinations in 2020, will be at least CPI and be also subject to the business conditions. The current low inflation environment affects CPI-X adjusted revenue allowances that SKI’s portfolio businesses are permitted to recover. In addition, SKI expects to become a taxpayer in the short term. The timing and amount of tax payable will be dependent on a number of factors including the underlying financial performance of the investment portfolio businesses, tax timing differences and, in the longer term and the outcome of existing disputes with the Australian Taxation Office (ATO). There is strong pipeline of value accretive business opportunities which would require TransGrid to retain a further cash to fund strong growth in unregulated capex (infrastructure connections) in 1H2018. Furthermore, the transition to a new energy future is creating investment opportunities in both the regulated as well as unregulated areas in all businesses. In addition, TransGrid is currently retaining surplus cash to fund value accretive investment opportunities in unregulated infrastructure connection assets. A more efficient funding structure has been agreed and is in the process of being implemented.
 

SKI assets base (Source: Company reports)

Opportunities from Renewal Energy Zone: There is an emerging need for the large scale renewables as AEMO (Australian Energy Market Operator) modelling indicates up to 25-30 GW of new wind and large-scale PV could be built in the National Electricity Market (NEM) by 2037. Moreover, expected coal closure is opening opportunity for renewable energy sources. Over 45 TWh of coal fired generation is expected to retire by 2030. The Renewable Energy Zones (REZs) are efficient as AEMO has undertaken work to identify REZs so that they can be incorporated into the ISP to promote economies of scale and improve the efficiency of new connections. Further, interconnection capacity will be pivotal to meeting reliability and security objectives and long term NEM renewable energy targets. Moreover, as per Integrated System Plan (ISP), opportunities for new transmission investment arising through strategic co-ordination of transmission and generation outlined in the plan are being prepared by AEMO. Overall, in NSW alone, over the next 20 years almost 10GW of capacity is required to replace ageing coal generation.
 

Coal closure offers opportunity (Source: Company reports)

More focus on Network utilization: Distribution network costs account for less than over 25% of a residential retail bill in South Australia and Victoria. Moreover, distribution network costs in South Australia have risen by less than CPI since it was privatized in 1999. Regulators are constantly pursuing at network use as a measure of efficient investment in the businesses. In 2017, the ACCC considered levels of use, comparing privately-owned with government-owned or recently privatized network operators. The group’s distribution networks clearly have high levels of use against the other Australian electricity networks. The group is trying to leverage their edge against its competitors and have submitted to the ACCC, that private networks perform better and offer a better customer service against the networks that are government-owned or were recently privatized. They are also trying to offer the government’s point of view of cutting costs to customers who should pursue partnerships with the private sector. The group believes that they are well placed to leverage these opportunities as they arise. Meanwhile, SKI’s aggregated proportional regulated electricity revenues are expected to increase further, including CitiPower by 1.99%; Powercor by 3.08% both slated from 1^st January 2018; SA Power Networks by 2.40% to 30 June 2018; 2.90% expected from 1^st July 2018; and TransGrid by -1.66% to 30 June 2018.The company has demonstrated success of portfolio business cost-out programs. The Portfolio businesses management teams are incentivised to continue to deliver efficiencies


Industry leading utilization (Source: Company reports)

Stock performance and buying of shares by directors: The shares of SKI have risen 6.36% in the last three months as on May 11, 2018 and we expect the momentum to continue in the coming months. The stock also has a solid dividend yield of 6.52%. In FY17, Powercor was ranked No 1 while CitiPower was ranked No 2 distribution network by AER as per the latest benchmarking report. SA Power Networks ranked No 1 on a State by State comparison. The company in FY 17 has delivered higher distributions to investors due to the efficiency and productivity gains within its strongly performing investment portfolio businesses. Additionally, SKI expects significant opportunities in new energy landscape, due to the improved regulatory certainty and efficient transition to higher use of renewables. SKI has delivered the growth of 42.5% in FY 17 in contracted asset base, predominantly on the back of new renewable connections. Meanwhile, director Karen Lee Collett Penrose has acquired 5,300 shares to add to the earlier holding of 50,000. Further, Greg Martin has acquired 50,000 shares to add to the earlier holding of 50,000. Further, the group’s look through operating cash flows cover the distributions by 1.6x. Based on the foregoing, we give a “Buy” recommendation on the stock at the current price of $ 2.330, ahead of the Annual General Meeting scheduled for May 24, 2018.
 

SKI Daily Chart (Source: Thomson Reuters)

 
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