Company Overview: Contact Energy Limited (ASX: CEN) is a diversified and integrated energy company, which focuses on the generation of electricity and sale of electricity & gas in New Zealand. The company is led by an experienced team, committed to customers, communities, and shareholders. The company owns and operates 11 power stations (as on 30 June 2020) and sells electricity on the wholesale market. As a retailer, CEN sells products and services to thousands of individuals and businesses to fulfil their energy and broadband needs. The company’s strategy is focused on delivering strong operational performance and providing sustainable value for customers and shareholders.

CEN Details

Long-term Outlook Supported by 152-megawatt Geothermal Power Station at Tauhara: Contact Energy Limited (ASX: CEN) is a leading energy retailer in New Zealand that sells products and services to thousands of individuals and businesses to fulfil their energy and broadband needs. As on 25 March 2021, the company’s market capitalisation stood at ~A$6.47 billion. In order to play an essential role in accelerating the decarbonisation of the New Zealand economy, CEN intends to maintain flexibility around investment options across multiple, renewable energy sources. Further, CEN is focused on digitisation, optimise its spending, and considering adjacent products and services to maintain its position as a leading energy retailer in New Zealand. Over the last five years (2016 to 2020), the company has witnessed significant improvement in its bottom line, rising from a net loss of NZ$66 million in FY16 to NZ$125 million in FY20.

Looking ahead, the company is focused on the development of a new 152-megawatt geothermal power station at Tauhara.  It believes that Tauhara geothermal project is New Zealand’s best low-carbon renewable electricity opportunity and is suitable for displacing baseload fossil fuel generation from the national grid. This project will not be reliant on weather and will be in operation 24X7. Construction of the project is expected to be completed in the middle of 2023. CEN is also undertaking a strategic review of the future role of all thermal assets in the Contact portfolio. With its recently announced NZ$400 million equity raising, the company seems well placed to reduce its net debt and to fund its Tauhara Project and other future growth projects.

Past Five-Years Performance (Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group)

H1FY21 Result Highlights: Despite the uncertainty around gas availability, and the doubt swirling around the future of the Tiwai Point smelter, CEN reported decent financial performance in H1FY21, underpinned by higher wholesale prices and disciplined approach to managing commodity risks. CEN’s earnings before net interest expense, tax, depreciation, amortisation, and change in fair value of financial instruments (EBITDAF) for H1FY21 stood at NZ$246 million, up 11% on the previous corresponding period (pcp). Statutory profit for H1FY21 stood at NZ$78 million, up 32% on pcp. During the period, the company approved a NZ$580 million further investment for the development of a new 152MW geothermal power station at Tauhara, near Taupō.

H1FY21 Results (Source: Company Reports)

FY20 Result Highlights: For the year ended 30 June 2020, the company reported EBITDAF from continuing operations of NZ$451 million, down by 11% on FY19 (continuing operations), due to lower renewable generation, lower wholesale prices and the impact of rising costs of thermal generation and restricted gas supply. Operating free cash flow for FY20 stood at NZ$290 million, down by 13% on FY19 (continuing operations), mainly due to lower operating earnings, partially offset by lower stay-in-business capital expenditure and interest costs. Statutory net profit for FY20 stood at NZ$125 million in FY20.

Key Metrics (Source: Company Reports)

Key Metrics: Despite the uncertainty around gas availability, and the doubt swirling around the future of the Tiwai Point smelter, the company’s profitability margins in FY20 have improved over previous year, demonstrating the resilience of the company’s business. Gross margin for FY20 stood at 31%, up from 28.4% in FY19. EBITDA margin for FY20 stood at 21.5%, higher than 20.3% in FY19. Current ratio for FY20 stood at 0.66x.

Past 5-year Financial Performance for Year Ending 30 June; Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

Top 10 Shareholders: The top 10 shareholders together form around 26.28% of the total shareholding, while the top four constitutes the maximum holding. BlackRock Institutional Trust Company, N.A. and BlackRock Advisors (UK) Limited are holding a maximum stake in the company at 7.04% and 5.53%, respectively, as also highlighted in the chart below:

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

Decent Track Record of Paying Dividend: For FY20, the company paid an annual dividend of 39 NZ cents per share, in line with FY19. As per the CEN’s revised dividend policy, CEN is targeting a pay-out ratio of between 80-100% of the average operating free cash flow of the previous four financial years. For H1FY21, the company has declared an interim cash dividend of 14 NZ cents per share, which will be imputed up to 9 NZ cents per share for qualifying shareholders. The payment date for H1FY21 dividend is 30 March 2021. For FY21, the company expects its full-year dividend to be around 35 NZ cents per share. At CMP of A$6.210, the company’s annual dividend yield stood at 5.06%.

Dividend Trend (Source: Company Reports)

Gas Tolling Arrangement with Nova Energy: On 24 March 2021, the company announced that it has entered into a gas tolling arrangement with Nova Energy. As per the agreement, CEN will purchase 3.6PJ of gas at market prices, which will support the operation of its efficient Taranaki Combined Cycle plant during winter 2021. This agreement increases the efficiency of thermal generation as it allows gas to be directed to the most efficient electricity generating plant in a period of reduced gas availability and low hydro inflows.

Developing Pipeline of Large-scale Wind Farm Opportunities: On 23 March 2021, the company announced that it has teamed up with wind generation experts Roaring40s Wind Power Ltd (‘Roaring40s’) to build a pipeline of large-scale wind farm opportunities in New Zealand over the next six years. A pipeline of flexible and low-cost wind projects will help CEN in higher market demand scenarios and will further improve its high quality, low-cost, baseload geothermal development pipeline.

NZ$400 million Equity Raising: In February 2021, the company announced a NZ$400 million equity raising, comprising a NZ$325 million underwritten placement (Placement) and an underwritten offer to shareholders in New Zealand and Australia to raise up to NZ$75 million (Retail Offer). CEN intends to use the proceeds from the equity raise to reduce its net debt and to fund the Tauhara Project and other future growth projects. On 16 February 2021, the company announced that it had completed the bookbuild for the NZ$325 million institutional Placement, which received strong support from existing institutional shareholders and also attracted significant bids from other institutional investors. On 11 March 2021, the company announces that its non-underwritten NZ$75 million retail offer has closed oversubscribed.

Key Risks: The company is exposed to the risk related to fluctuations in the wholesale electricity prices. Further, the company is also exposed to the uncertainty surrounding the COVDI-19 pandemic. The company is also exposed to regulatory risk as changes to regulation impact costs of business.

Outlook: In order to navigate through the challenges and opportunities emerging over the short term and medium term, CEN has renewed its strategy and is now focused on decarbonisation, growing demand and maintaining flexibility around investment options across renewable energy sources, reviewing its core processes and organisational structure to bring more efficiency, and optimising its spending. Currently, the company is progressing with the development of Tauhara geothermal project in New Zealand, which is expected to be completed in the middle of 2023. For FY21, the company expects its total cash spend to be in the range of NZ$255 million – NZ$270 million. Geothermal volumes in FY21 are expected to be around 3,100GWh. CEN intends to reduce its net debt and become more flexible to fund its Tauhara Project and other future growth projects. Full-year dividend in FY21 is expected to be around 35 NZ cents per share. With its flexible and largely renewable portfolio of electricity generation assets, CEN is uniquely placed as a crucial renewable energy generator and retailer.

Valuation Methodology: P/E Multiple Based Relative Valuation (Illustrative)

Data Source: Refinitiv, Thomson Reuters, Analysis by Kalkine Group

*% Premium/(Discount) is based on our assessment of the company’s NTM trading multiple after considering its key growth drivers, economic moat, stock's historical trading multiples versus peer average/median, and investment risks.

** 1 NZD = ~0.92 AUD

Stock Recommendation: The stock of CEN has corrected by 23.71% and is trading lower than the average 52-week price level band of A$5.3- A$10.560, offering a decent opportunity for accumulation. On the technical analysis front, the stock has a support level of ~A$5.279 and resistance of ~A$7.363. We have valued the stock using P/E multiple based illustrative relative valuation method and arrived at a target price with an upside of low double-digit (in % terms). We believe that the company can trade at a slight discount to its peers, considering the ongoing impact from the COVID-19 pandemic, uncertainty around gas availability, and the doubt swirling around the future of the Tiwai Point smelter. We have taken peers like Cooper Energy Ltd (ASX: COE), Mercury NZ Ltd (ASX: MCY), Meridian Energy Ltd (ASX: MEZ), etc., which comes under energy space. Considering the company’s decent H1FY21 results, recent equity raising of NZ$400 million, ongoing focus on net debt reduction and development of Tauhara Project, modest long-term outlook, current trading level and valuation, we give a “Buy” recommendation on the stock at the current market price of A$6.210, down by 2.205% as on 25 March 2021.

CEN Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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