NEW ZEALAND Meridian Energy 5 October 2009 Performance evaluation Meridian Energy equity valuation Macquarie Research’s discounted cashflow-based equity valuation for Meridian Energy is $4,762m (nominal WACC 8.8%, asset beta 0.60, TGR 3.0%). Forecast financial model A detailed financial model with explicit forecasts out to 2030 has been completed and is summarised through this report. 12- and 24-month target valuations The 12-month ($4,802m) and 24-month ($4,856m) target valuations for the company have been derived by rolling forward the discounted cashflow model 12 and 24 months respectively and deducting from these values the forecast 12- and 24-month dividends to the Crown. Financial model assumptions and commentary We have assessed the sensitivity of our equity valuation to a wide range of inputs. Broadly, the sensitivities are divided into four categories: generation assumptions, electricity demand, financial and price path. We highlight and discuss a number of key model input assumptions in the report: Inside Wholesale electricity price path; Electricity demand and pricing; Performance evaluation 2 The New Zealand Aluminium Smelters (NZAS) supply contract; Valuation summary 5 Meridian Energy’s generation development pipeline. Financial model assumptions and commentary 6 Financial statements summary 14 This bespoke research is provided for the use of the New Zealand Treasury. Financial flexibility and generation development 17 Sensitivities 18 Alternative valuation methodologies 19 Performance relative to SCI 20 Analyst Stephen Hudson 649 363 1414 [email protected] Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures. Macquarie Research Equities - Report Meridian Energy Performance evaluation Meridian Energy equity valuation Macquarie Research’s discounted cashflow-based equity valuation for Meridian Energy is $4,762m (nominal post tax WACC 8.8%, asset beta 0.60, TGR 3.0%). Forecast financial model A detailed financial model with explicit forecasts out to 2030 has been completed and is summarised through this report. We have used actual financial results from FY08 as a base. 12- and 24-month target valuations Our 12-month ($4,802m) and 24-month ($4,856m) target valuations for the company have been derived by rolling forward the discounted cashflow model 12 and 24 months respectively and deducting from these values the forecast 12- and 24-month dividends to the Crown. Sensitivity analysis of main valuation drivers We have assessed the sensitivity of our equity valuation to a wide range of inputs. Broadly, the sensitivities are divided into four categories: generation assumptions, electricity demand, financial and price path. Alternative valuation methodologies We have assessed a comparable company valuation for the company of $4,864 – 5,743m. This is based on the trading valuations of comparable global generator/retailers. This valuation provides a cross check of the equity valuation based on our primary methodology, discounted cashflow. In addition, we have prepared a sum-of-the-parts based valuation for Meridian using European transaction multiple precedents. This valuation is assessed as $8,670 – 10,866m. We think sum-of-the-parts valuations are of limited use due to the limited set of local market comparables and the fundamentally different nature of the European comparables which have been used. Financial model assumptions and commentary We highlight and discuss a number of key model input assumptions in the report: Development pipeline. The company has proposed a number of greenfield wind and hydro generation developments totalling in excess of 1,900 MW. We have explicitly modelled projects which appear to have a high probability of being completed in a reasonable timeframe. These are Te Uku, Project Central Wind and Mill Creek. Retail and SME pricing. As at February 2009, Meridian Energy was pricing the energy component of its mass market electricity volumes at an approximate 3.8% discount to the average market pricing – up from an approximate 3.4% discount two years prior. We have attempted to back out Meridian Energy’s commercial/SME fixed pricing by calculating the commercial/SME pricing discount seen in historical periods (based on pricing information from the MED). On average, from FY01-FY08, commercial pricing was at a 4% discount to mass market pricing. We assumed this discount in our forecasts. NZAS supply contract renewal and pricing. We estimate that up to 5,256 GWh (~44% of total generation volumes in FY08) of energy will be sold to NZAS for its Tiwai Point aluminium smelter under the current contract. 5,256 GWh assumes NZAS purchase the amount available under its contract of 600 MW pa. We have reduced the volume sold in FY09 to 75% of normal volume, reflecting the transformer outage on 9 November 2008. In addition, given the depressed aluminium market, we assume Tiwai Point will operate at ~90% capacity (the take-or-pay level of NZAS’s supply contract) in FY10 and FY11. Post-2012, we assume up to 5,011 GWh of energy is contracted for to NZAS (based on contract volume of 572 MW pa). Pricing for the current contract, which expires at the end of 2012 is believed to currently be ~6.0c/kWh. It is assumed this will increase at CPI until the end of the contract. We have assumed prices post-2012 increase with reference to the market price for NZ electricity, the world price for aluminium and inflation, with each factor having an equal weighting. 5 October 2009 2 Macquarie Research Equities - Report Meridian Energy Other long-term contract hedges. We have estimated the volume sold by Meridian Energy under other long-term hedge contracts. We put this volume at 2,750 GWh (21% of total generation volumes) over FY09. We have assumed that these volumes are priced in line with forecast wholesale prices. Wholesale electricity price paths. We have reconstructed our wholesale electricity price forecast since the last report (Meridian Energy, 13 June 2008). Based on expected demand and supply (taking into account future projects coming online), we expect that the wholesale electricity price will approach the LRMC of wind generation by 2020 (the year in which other, cheaper, generation alternatives have been exhausted). We consider new thermal generation capacity will be limited (beyond Contact’s Taranaki peakers) due to difficulties in obtaining adequate gas supply, and the availability of cheaper geothermal development options. We estimate the current LRMC of wind as $100/MWh (2009 dollars). We note, however, that this LRMC is highly sensitive to currency, turbine pricing and cost of capital assumptions. Since the 2008 report, we have revised several assumptions in the model. The wholesale and retail price paths have been updated to reflect primarily a delay in the introduction of carbon charges, which are now introduced in FY12 (instead of FY10) as well as increased mass market competition. Included in this model are new generation projects where there is sufficient certainty surrounding the completion of the project. We have revised short-term electricity usage forecasts to reflect the current economic environment. In addition, we have made several changes to the mechanics and assumptions in the model to reflect the latest publicly available information. Fig 1 Wholesale and retail electricity price path forecasts Wholesale and retail price paths 300 250 200 150 $NZ 100 Wholesale electricity price 50 Retail electricity price 0 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Macquarie Research, September 2009 Arc Innovations. The Arc Innovations smart metering business has not been explicitly modelled in our Meridian Energy projections and therefore its DCF-based equity valuation. We do however attempt to make some allowance for the intellectual property value within Arc Innovations including an estimated book value of $75m in the alternative equity valuations. WhisperTech, WhisperGen and Energy for Industry. We have not explicitly modelled the WhisperTech and WhisperGen CHP businesses, and the Energy for Industry subsidiary, as these are not part of Meridian’s core operations. An estimated value for these businesses of $100m is included in the alternative company valuations. 5 October 2009 3 Macquarie Research Equities - Report Meridian Energy Fig 2 Meridian summary financials (MER: $2.98) Profit & Loss 2007A 2008A 2009E 2010E Operating Revenue $m 1775 2603 2979 3015 EBITDAF - Recurring $m 478 371 588 586 Depreciation $m 109 140 144 146 Amortisation $m 8 13 0 0 EBIT - Recurring $m 360 218 444 441 EBIT $m 360 264 444 441 Net Interest Expense $m 56 67 72 82 Pre-Taxation Profit $m 304 198 372 359 Taxation Expense $m 104 69 112 108 Profit after Taxation $m 200 129 260 251 Tax-affected Non -Recurring Items $m 0 31 0 0 Pre Abnormal Profit after Tax $m 200 97 260 251 Adjusted Earnings 1 $m 208 111 260 251 1 Adj for non-recurring items and goodwill amort Key Assumptions Wholesale Electricity Price $/MWh 54 105 58 63 Net Margin - Own Generation $/MWh 96 92 103 94 Net Margin - Hedge Output $/MWh 47 92 44 44 Own Generation output GWh 12678 11914 12846 13131 Discounted Cashflow Valuation Profit and Loss Ratios 2007A 2008A 2009E 2010E PER (adj Earnings) x 22.9 43.1 18.3 19.0 PV FCFs Available to Owners $m 5761 EPS (adj Earnings) c 13.0 6.9 16.3 15.7 Less Net Debt (inc Associate debt share) $m (999) EPS (Reported) c 12.5 8.0 16.3 15.7 Equity Value $m 4762 DPS c 23.0 18.6 13.0