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

Operational Excellence of Victoria Power Networks: Spark Infrastructure Group (ASX: SKI) has 49% ownership in Victoria Power Networks, which has a World Class operations’ objective, and the program has posted the sustained total savings of approximately $151m p.a. This has been possible through the key initiatives that include the savings in field delivery through the successful negotiation of lower rates or contractor hours. It brought the management of vegetation in-house, has put iPads for field use, which reduced the administration and the paperwork. Moreover, Victoria Power Networks has streamlined the procurement processes and savings through the renegotiation of contracts. Simplified maintenance processes and updated maintenance policies to avoid unnecessary work have also been put in place, and then rightsizing the corporate functions (first wave) was a key focus. Additionally, there was continuous improvement aligned with the five strategic pillars and current run rate of $30m p.a. of benefits (2/3 opex) has been delivered. Meanwhile, for Victoria Power Networks, the new improvement program started with savings of $27m identified in HY 2017. The final determination for 2016-20 delivered $180m revenue related to Preliminary Determination as recovered from January 2017. Furthermore, in 2017, the Australian Energy Regulator (AER) had approved Powercor’s Contingent Project Application related to Tranche 1 REFCL Program. The additional revenues of $28.5m will be accounted over the years 2018-2020.
 

Investment Portfolio (Source: Company Reports)
 
Powering Ahead Efficiency Program under SA Power Networks: SKI has 49% stake in SA Power Networks, who is the sole operator of South Australia’s electricity distribution network. SA Power Networks’ Productivity and efficiency improvements to date have posted ongoing annual benefits of approximately $110m per annum. This is possible through the innovative procurement outcomes, that lead to material and services cost savings across the organization. There is improved debt refinancing, innovative asset management practices leading to improved asset management strategy and depot realignment and implementation of standard operating model. Further there is reduced external labour spend and lean/agile IT function. Meanwhile, the group has highlighted that SA Power Networks’ Powering Ahead is the next stage of business wide improvement program. It was launched in August 2017 and is focused on the highest-value opportunities. The Powering Ahead aims to deliver approximately $40m p.a. of benefits. This can be attained through the key initiatives that include strengthening capital management and planning, ensuring optimal work selection and workflow through the implementation of field productivity metrics to improve performance and reviewing the highest value processes to improve efficiency through automation, standardisation and centralization. Further, it can be done through the improvement of customer outcomes, especially faster restoration for network operations, enhanced customer processes and systems and identifying the cross-functional and corporate function opportunities for automation and efficiency. Furthermore, there is a continuous efficient delivery of NBN roll-out in South Australia (generating revenue over $225m since inception).
 
Strong Performance of TransGrid: SKI has 15% interest in TransGrid, which is the largest high-voltage electricity transmission network in the National Electricity Market (NEM) by electricity transmitted. TransGrid has performed strong in several independent benchmarking studies. It has achieved 9% gross savings in 12 months to 30 June 2017 and is focused on delivering a further 3% reduction in subsequent 12 months. The strong performance of TransGrid is due to the higher internal labour utilization, process streamlining and reduced duplication of roles and improved contract management and procurement practices. Further, TransGrid has improved the scoping of works and management of internal and external service providers, optimized the routine maintenance frequency, vegetation management and patrolling of overhead lines and has used the application of life cycle management approaches to manage capital replacement requirements over the long term. On the other hand, SKI has appointed Jeremy (Jerry) Maycock as the new Chair of TransGrid. Meanwhile, The AER’s Draft Decision was received at the end of September 2017. The final regulatory determination is expected to be received in April 2018 and will be effective from July 2018, which will provide 5 years of cash flow certainty.
 

TransGrid’s regulatory update (Source: Company Reports)
 
Growth in Renewable Generation: The growth is expected through Networks and Energy Storage with TransGrid identified as backbone of National Electricity Market (NEM) being placed at the center of energy market transition to renewable energy. Particularly, Networks are expecting strong growth in connections business opportunities straddling transmission lines of the NEM. AEMO and TNSPs are working for identification of the priority renewable corridors. The Pumped-hydro energy storage proposals are assessed in SA, TAS, NSW and QLD and there are increasing battery installations.
 
1H 2017 Financial Performance: SKI in the first half of 2017 reported 7% growth in the adjusted aggregated proportional EBTDA to $305.7M. The underlying profit (before loan note interest and tax) grew to $138.7M. Moreover, SKI’s Aggregated proportional Regulatory Asset Base (RAB) and Contracted Asset Base (CAB) grew 1.2% to $5,739M in the first half of 2017.
 

1H 17 Financial Performance (Source: Company Reports)
 
Capital Management: ETSA Utilities Finance Pty Limited, the funding vehicle for SA Power Networks, has placed $100 million of 6-year floating rate Australian Medium-Term Notes (AMTNs) maturing in December 2023 successfully. This is along with the drawdown of a $250 million syndicated bank debt facility maturing in June 2021. With this, the company has completed the refinancing of $350 million of AMTN debt that matures in April 2018 and there is no other maturing debt to be refinanced in 2018. Meanwhile, SKI has reaffirmed its distribution guidance for 2017 and 2018, of 15.25 cps and 16.0 cps, that represents annual growth of 5.2% and 4.9%, respectively. However, this is subject to business conditions and the guidance is based on expected distributions from the asset portfolio. SKI’s objective is to have post returns in excess of CPI in the current environment.
 
Areas of Focus: SKI’s areas of focus are to ensure that their networks maintain the focus on the efficiency. The company is focusing on the continued TransGrid execution against the acquisition business plan. SKI is promoting the grid interconnectivity, for example, the new NSW/SA interconnector, increased connection to renewable energy zones etc. Moreover, SKI is ensuring networks are not restricted from providing valuable system strength and inertia services. SKI is supporting the proactive evolution of network businesses with expansion into niche areas associated with ‘behind the meter’ customer solutions, battery storage and consulting services. Furthermore, the company is influencing policy and regulation through the proactive participation.
 
Outlook and Guidance: The regulated electricity distribution revenues are projected to increase further in years 3 to 5 of the current regulatory periods.  The AER’s CPI-X revenue sculpting method has been flagged to help increase the revenues for CitiPower and Powercor (from January 2018) and SA Power Networks (from July 2016) through the remainder of the current regulatory periods. Further, TransGrid’s regulated transmission revenue is expected to be flat for the remainder of its regulatory period that ends at June 2018. Moreover, the transition to a higher proportion of renewable energy generation has created investment opportunities in both the regulated and unregulated areas in all businesses. Additionally, SKI has posted success of portfolio business cost-out programs through the continuous improvement (Victoria Power Networks), Powering Ahead (SA Power Networks) and ACE (TransGrid). The portfolio businesses’ management teams are given incentives to continue to deliver efficiencies. In addition, the company has a strong pipeline of value accretive business opportunities, that may require TransGrid to retain additional cash to fund strong growth in unregulated capex (infrastructure connections).
 
Industry Regulatory Opportunities and Challenges: Opportunities for SKI relate to the acknowledgement under compensation, while rate of return guideline is expected to reflect the current positions and improve the transparency and predictability. Further, the recent energy policy announcements are expected to provide certainty and level playing field for investment. The regulator decisions confirm the access of the company to the financial incentives where the business is efficient. Moreover, the ring fencing arrangements provide clarity and remove regulatory jurisdiction over new and innovative services. In October 2017, the Australian Government also released the National Energy Guarantee which provides certainty to the energy sector to support efficient investments in connections, interconnections and storage. Meanwhile, there are some challenges for SKI as well, for instance, regulatory treatment of inflation that undercompensates businesses when the inflation is low can impact the group. Then Rate of Return needs to be reviewed and updated for current market conditions specifically. Furthermore, the regulatory investment test is still unnecessarily onerous and might undervalue the network solutions. All in all, for company to access financial benefits, it is important for SKI to demonstrate and maintain relative efficiency.
 

Trend of Distribution (Source: Company Reports)
 
Stock Performance: SKI stock has fallen 10.51% in three months as on January 25, 2018. However, SKI has the portfolio of high quality regulated businesses and remains focused on the cost management. SA Power Networks and Victoria Power Networks have historically done well, and it is expected that TransGrid seeks to emulate their class-leading performance. Moreover, the new renewable generation is creating excellent opportunities in the infrastructure connections space for all of the company’s businesses and underscores the importance of transmission interconnection between States to the efficient operation of the National Electricity Market. Additionally, SKI’s distribution businesses (~83% of proportional RAB) gives the cash flow certainty to June 2020 (SA Power Networks) and December 2020 (Victoria Power Networks). Returns on equity for RAB, upside from TransGrid opportunities and non-regulated opportunities in SAPN and VPN are expected to provide boost to the stock price. Based on the foregoing, we give a “Buy” recommendation on the stock at the current price of $2.31
 

SKI Daily Chart (Source: Thomson Reuters)

Disclaimer
 
The advice given by Kalkine Pty Ltd and provided on this website is general information only and it does not take into account your investment objectives, financial situation or needs. You should therefore consider whether the advice is appropriate to your investment objectives, financial situation and needs before acting upon it. You should seek advice from a financial adviser, stockbroker or other professional (including taxation and legal advice) as necessary before acting on any advice. Not all investments are appropriate for all people. Kalkine.com.au and associated pages are published by Kalkine Pty Ltd ABN 34 154 808 312 (Australian Financial Services License Number 425376). The information on this website has been prepared from a wide variety of sources, which Kalkine Pty Ltd, to the best of its knowledge and belief, considers accurate. You should make your own enquiries about any investments and we strongly suggest you seek advice before acting upon any recommendation. Kalkine Pty Ltd has made every effort to ensure the reliability of information contained in its newsletters and websites. All information represents our views at the date of publication and may change without notice. To the extent permitted by law, Kalkine Pty Ltd excludes all liability for any loss or damage arising from the use of this website and any information published (including any indirect or consequential loss, any data loss or data corruption). If the law prohibits this exclusion, Kalkine Pty Ltd hereby limits its liability, to the extent permitted by law to the resupply of services. There may be a product disclosure statement or other offer document for the securities and financial products we write about in Kalkine Reports. You should obtain a copy of the product disclosure statement or offer document before making any decision about whether to acquire the security or product. The link to our Terms & Conditions has been provided please go through them and also have a read of the Financial Services Guide. On the date of publishing this report (mentioned on the website), employees and/or associates of Kalkine Pty Ltd do not hold positions in any of the stocks covered on the website. These stocks can change any time and readers of the reports should not consider these stocks as advice or recommendations.