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Genesis Energy NEW ZEALAND Genesis Energy 13 June 2008 Performance evaluation Genesis Energy equity valuation Macquarie Research’s discounted cashflow based equity valuation for Genesis Energy is $2,115m (nominal WACC 9.17%, 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 month and 24 month target valuations Our 12 month ($2,257m) and 24 month ($2,433m) 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, these sensitivities are divided into five categories: generation Inside assumptions, electricity supply, gas supply, financials and price path. Performance evaluation report 2 This report highlights and discusses a number of key model input assumptions: Valuation summary 5 ⇒ The extent to which Huntly coal is backed off; Financial model assumptions and ⇒ The company’s retail and SME pricing position; commentary 11 ⇒ Future fuel cost position; Financial statements summary 18 ⇒ Genesis Energy Retail Gas margins; and Genesis Energy historic and forecast performance 21 ⇒ Wholesale electricity price paths. Historic and forecast performance versus SCI Financial flexibility and generation development 22 We have analysed the spread between Genesis Energy’s return on funds and its WACC to gauge its historic and forecast financial performance; Alternative valuation methodologies 23 We have compared our forecasts for Genesis Energy against those outlined in its Statement of Corporate Intent (SCI). Going forward, Macquarie Research forecasts that Genesis Energy will average a -0.9% return to WACC over the next five years (FY08–12) or a return approximately equal to its cost of capital; Beyond FY12, Macquarie Research expects Genesis Energy to yield steadily Analyst increasing excess returns, largely as a result of increasing margins on its Stephen Hudson hydro and wind generation. Hydro and wind generation made up around 21- 649 363 1414 [email protected] 25% of the company’s generation (excluding co-generation output) over FY02-07. Relative SOE and listed gentailer disclosure levels We include a summary of our assessment of the relative disclosure levels for each SOE electricity gentailer and the two listed comparable companies. Please refer to the important disclosures on inside back cover of this document, or on our website www.macquarie.com.au/research/disclosures. WS: CSF_Sydney: 2439553: v2 Macquarie Research Equities - Report Genesis Energy Performance evaluation report Genesis Energy equity valuation Macquarie Research’s discounted cashflow based equity valuation for Genesis Energy is $2,115m (nominal WACC 9.17%, asset beta 0.60, TGR 3.0%). Forecast financial model A detailed financial with explicit forecasts out to 2030 has been completed and is summarised through this report. 12 and 24 month target valuations Our 12 month ($2,257m) and 24 month ($2,433m) 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 five categories: generation assumptions, electricity supply, gas supply, financial and price path. WACC analysis We have completed a small report in conjunction with this evaluation on the composition of the Genesis Energy WACC. Alternative valuation methodologies We have assessed a sum of parts valuation for Genesis Energy based on reported transaction asset multiples. The valuation multiples have only been applied to one generating unit at Huntly due to the backing off of generation assumed in the DCF model. The equity value range assessed is $2,603–3,206m. The variance between this range and the DCF based equity valuation could be explained by the fact that international transaction multiples will tend to imply a valuation above the DCF based valuation due to the potential control premia and lower discount rates embedded in these. Additionally, we have analysed a wide number of comparable global generator/retailers in order to cross-check the equity valuation based on our primary methodology, discounted cashflow. Financial model assumptions and commentary We highlight and discuss a number of key model input assumptions in the report: The extent to which Huntly coal is backed off. Overall this station is forecast to operate with a capacity factor of 45%, down from the expected FY06-07 peak of 72%. This reflects Macquarie Research’s expectation that one 250 MW unit will be backed off and committed as reserve capacity ahead of the full introduction of a New Zealand emission trading scheme in 2010; Retail and SME pricing As at May 2007. Genesis Energy was pricing its mass market electricity volumes at an approximate 3% discount to the average market pricing – down from an approximate 7% discount two years prior. This discount strategy may well have been the result of the company’s decision to proceed with the e3p CCGT greenfield plant as well as the impact from expected higher fuel costs as coal is backed off at Huntly and Huntly/e3p’s fuel mix shifts towards higher cost and less flexible gas supply. Average commercial/SME pricing for the company is estimated to be 11.6c/kWh for FY07 – a relatively large discount to the published average commercial pricing (Statistics NZ PPI series). Future fuel costs. Macquarie Research forecasts long run thermal coal prices (Australia to Japan) at US$55/t. Macquarie Research forecasts, consistent with the MED’s base case as outlined in its 2006 ‘Energy Outlook to 2030’, that imported LNG will be required in NZ from 2020; 8 Aug 2008 2 Macquarie Research Equities - Report Genesis Energy Genesis Energy Retail Gas. We have used Contact Energy’s unit pricing as a proxy for that of Genesis Energy. The company’s gas fuel cost and estimated distribution costs have been used to calculate the business unit’s operating margin. Disclosure levels across this business segment are relatively low. We estimate that the segment contributed around 29% of FY07 EBITDA. Wholesale electricity price paths. We have assessed three wholesale electricity price paths: nil carbon costed wholesale electricity, a full ETS based carbon cost at $15/t C02e from FY10 and a Comalco exit from NZ from 2012. Post the recent renegotiation of the Meridian Energy-Comalco supply contract, this scenario is now of less relevance. Historic and forecast performance versus SCI We have analysed the spread between Genesis Energy’s return on funds employed and its WACC to gauge, broadly, its historic and forecast financial performance. Genesis Energy has averaged annual returns of around -0.5% pa under WACC over the past five years. In other words, it has broadly returned its cost of capital over this period (based on a post tax nominal WACC of 9.17%). Historic performance has however been relatively volatile, ranging from the 2.7% excess return in FY04 to a negative return to WACC of 3.7% in FY07. Although not clearly observable, the variation of returns appears to have been driven by a combination of higher depreciation on the 30 June 2005 generation asset revaluation, higher thermal fuel costs (over FY05 average fuel costs were up around 13%) and the company’s increased gas retail presence during FY04 (a business with a higher ROCE compared to generation say). Going forward, Macquarie Research forecasts that Genesis Energy will average a -0.9% return to WACC over the next five years (FY08-12) or a return approximately equal to its cost of capital; Beyond FY12, Macquarie Research expects Genesis Energy to yield steadily increasing excess returns, largely as a result of increasing margins on its hydro and wind generation. Hydro and wind generation made up around 25% of the company’s generation (excluding co- generation output) over FY02–06. We have compared our forecasts for Genesis Energy against those outlined in its Statement of Corporate Intent (SCI). Relative SOE and listed gentailer disclosure levels We have set out in the report (figure 3) the key operating assumptions underpinning our DCF valuation for Genesis Energy. A summary of our assessment of the relative disclosure levels for each SOE electricity generator/retailer and the two major listed comparable companies is included (in the same figure 3). 8 Aug 2008 3 Macquarie Research Equities - Report Genesis Energy Fig 1 Genesis Energy summary financials (GEN $3.91) Profit & Loss 2006A 2007A 2008E 2009E Operating Revenue $m 1987 1774 1892 2036 EBITDAF - Recurring $m 210 173 227 202 Depreciation $m 51 53 62 57 Amortisation $m 17 17 0 0 EBIT - Recurring $m 142 103 166 145 EBIT $m 142 103 166 145 Net Interest Expense $m 0 (2) 33 31 Pre-Taxation Profit $m 142 105 132 114 Taxation Expense $m 58 44 43 34 Profit after Taxation $m 84 61 90 80 Tax-affected Non -Recurring Items $m 4 1 0 0 Pre Abnormal Profit after Tax $m 80 61 90 80 1 Adjusted Earnings $m 97 78 90 80 1 Adj for non-recurring items and goodwill amort Key Assumptions Market Gas Cost $/GJ 6 6 7 7 Wholesale Electricity Price $/MWh 103 67 69 70 Net Margin - Own
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