Stock of the Day – Spark Infrastructure (SKI)

Despite strong regulated tariff increases. Spark infrastructure’s revenue increased just 1.7% in the first half 2014. The main detractors were soft volumes and lower unregulated revenue. Operating cost were relatively well contained at the underlying networks increasing just 1%. A cost reduction program should keep the cost under control. Proportionate EBITDA increased 2% to AUD 347 million, tracking below expectations on the softer than expected revenue.


EBITDA + RAB  (Source – Company Reports)

Regulatory asset base or RAB continues to grow at a good clip up 6% on June last year on elevated capital expenditure. With growth being funded by a relatively conservative mix of retained earnings and debt, balance sheet continues to improve. Gearing measured as net debt to RAB is 77.8% down from 78.5% in December 2013. The target is to reduce gearing in the underlying assets to 75% by 2015. We believe Spark’s balance sheet is sound and the target gearing will put them in good positions to weather tough regulatory settings.


DPS + Net Debt (Source – Company Reports)
 
The tough regulatory environment further reduces the potential for sustainable excess returns. Spark look overvalued at present. Likely tough regulatory resets in 12 to 18 months will be material headwinds tow earnings. This may not require distributions to be reduced as the currently conservative payout ratio provides a buffer but with capital expenditure likely to remain high a small cut can’t be ruled out.


SKI Daily Chart (Source – Thomson Reuters)

Volumes can be volatile and fluctuate with weather and other factors, causing earnings to jump around. In the current environment of falling demand as a result of increased solar penetration and more energy efficient homes and appliances, the regulator must increase tariffs to ensure utilities earn a fair return. Historically utilities could over or under earn for a while given the regulator only adjusted demand expectations every five years at regulatory resets. Unregulated revenue can be lumpy driven by large customer initiated projects. Completion of the Elaine Terminal station caused a 25% reduction in unregulated revenue at the Victoria Power Networks or VPN while reduced spending by customer Electranet caused an 8% reduction at the South Australia Power Networks or SAPN. Unregulated revenue was at elevated levels in recent years. We put a SELL recommendation on the stock at the current price of $1.87.

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