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Meridian Energy NEW ZEALAND Meridian Energy Performance evaluation Meridian Energy equity valuation Macquarie Research’s discounted cashflow-based equity valuation for Meridian Energy (MER) is $6,531m (nominal WACC 8.6%, 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 in this report. Inside Financial model assumptions and commentary Performance evaluation 2 We discuss a number of key model input assumptions in the report including: Valuation summary 6 Wholesale and retail electricity price paths; Financial model assumptions 8 Electricity purchase to sales price ratio pre and post the HVDC link upgrade; Financial statements summary 18 HVDC link charging regime; Financial flexibility and generation Electricity demand growth by customer type; development 21 The impact of the Electricity Industry Act (EIA) asset transfer and VAS’; Sensitivities 22 The New Zealand Aluminium Smelters (NZAS) supply contract; Alternative valuation methodologies 23 Relative disclosure 24 MER’s generation development pipeline. Appendix – Valuation Bridge 26 Equity valuation sensitivities are provided on key variables. Alternative valuation methodology We have assessed a comparable company equity valuation for the company of $5,179m-$5,844m. This is based on the current earnings multiples of listed comparable generator/retailers globally. This valuation provides a cross-check of the equity valuation based on our primary methodology, discounted cashflow. This valuation range lies below our primary valuation due, in part to the positive net present value of modelled development projects included in our primary valuation. Relative disclosure We have assessed the disclosure levels of MER’s financial reports and presentations over the last financial period against listed and non-listed companies operating in the electricity generation and energy retailing sector in New Zealand. This bespoke research is provided for the use of the New Zealand Treasury. * Benmore Power Station (pictured) Stephen Hudson +64 9 363 1414 [email protected] 8 November 2011 Macquarie Securities (NZ) Limited Please refer to the important disclosures and analyst certification on inside back cover of this document, or on our website www.macquarie.com.au/disclosures. Macquarie Research Meridian Energy Performance evaluation Meridian Energy equity valuation Macquarie Research’s discounted cashflow-based equity valuation for Meridian Energy is $6,531m (nominal post tax WACC 8.6%, 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 in this report. We have used actual financial results from FY11 as a base. Sensitivity analysis of main valuation drivers We have assessed the sensitivity of our equity valuation to a 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 equity valuation for the company of $5,179m- $5,844m. The band is based on the average multiple for generators that are considered to be the closest comparable companies to Meridian Energy (Contact Energy and TrustPower). We then applied a band to this multiple to account for MER’s higher renewable generation bias and its relatively large pipeline of generation development options (at the upper end) and its high relative historic earnings volatility (at the lower end). The band involves subjective judgement, as only some of these factors can be isolated and quantified. Renewable generation companies globally are generally accorded a higher capitalisation multiple than conventional generators reflecting the value of a free- or low-fuel position when electricity price paths are positively sloped. This multiple has been compressed in recent years as perceived risks over renewable generation incentives have heightened. NZ generators trade at a premium to their international counterparts partly due this country’s low reliance on incentive regimes. This valuation provides a cross-check of the equity valuation based on our primary methodology, discounted cashflow. This valuation range lies below our primary valuation, due in part to the positive net present value of modelled development projects included in our primary valuation. Financial model assumptions and commentary We highlight and discuss a number of key model input assumptions in the report: Wholesale and retail electricity price paths: We have reconstructed our wholesale electricity price path forecast since the 2010 commercial valuation report. Based on expected demand and supply (taking into account future projects coming online), we continue to think that the wholesale electricity price path will approach the LRMC of wind generation by 2021 (the year in which other, cheaper, generation alternatives would be exhausted). We estimate the current LRMC of wind at $90/MWh (2011 dollars); this is lower than the previously estimated $100/MWh primarily due to a higher LT NZD/EUR assumption and a lower EUR denominated capital cost. Nearer term, prices are expected to generally fall somewhat short of LRMC-based prices given a flat demand outlook (although this will be dependent on hydrology conditions). Our retail price path for Meridian has lifted marginally despite a shift down in our wholesale price path. This reflects a slightly higher target long-run industry retail margin of around 6% and the modelling of separate retail price paths for gentailers (previously a uniform price path). Overall, we forecast that long-run wholesale and retail prices increase by an average 7% pa and 3% pa, respectively. The difference is mainly explained by the current low wholesale prices and relatively low network cost growth. 8 November 2011 2 Macquarie Research Meridian Energy Fig 1 Wholesale and retail electricity price path forecasts $NZ 300.0 Wholesale electricity price 2011 ($/MWh) Retail electricity price 2011 ($/MWh) Wholesale electricity price 2010 ($/MWh) 250.0 Retail electricity price 2010 ($/MWh) 200.0 150.0 100.0 50.0 - 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Macquarie Research, November 2011 NZ Emissions Trading Scheme (ETS) pricing forecasts: We have assumed the following NZ ETS pricing obligations for the stationary energy sector. Note, the current ETS legislation has the energy, transport and industrial sectors stepping up to a full obligation in 2013. A Government-appointed review panel recommended in September this year to slow this by phasing it in three steps in 2013, 2014 and 2015; this would effectively ease the price impact on households and businesses. Fig 2 Stationary energy NZ ETS pricing 2012 2013 2014 2015 2016 2017 2018 Proposed Surrender obligation % 50 67 83 100 100 100 100 Proposed Price cap $/NZU 25.00 30.00 35.00 40.00 45.00 50.00 reviewable Effective Proposed Price cap $/NZU 12.50 20.10 29.05 40.00 45.00 50.00 reviewable Macquarie price forecast - real $/NZU 12.50 20.10 20.10 20.10 20.10 20.10 20.10 Source: ETS Review 2011 Final Report, Macquarie Research, November 2011 Macquarie Securities has taken a more conservative view on the sector’s obligations capping price at $20.10/NZU (real) from 2013. This is due to uncertainty over the international carbon pricing framework from 2013 (i.e. when the first commitment period under the Kyoto Protocol comes to an end on 31 December 2012). Electricity Purchase to Sales Price Ratio: There are systemic differences between generation prices achieved and load prices paid due, primarily, to transmission constraints, geographical separation of generation and load centres, the ability to control generation output and the timing of load demand. These differences can be separated into a Generation Weighted Average Price (GWAP) factor and Load Weighted Average Price (LWAP) factor. We have forecast a GWAP and LWAP for Meridian Energy based on historical analysis and the outlook for transmission constraints and demand growth. This factor is applied to our benchmark wholesale price path to generation earnings and retailing costs. Note, our forecast ratio falls from 2012 as increased HVDC link capacity becomes available but then begins to rise slowly from 2015. Note, a smaller DC link tends to increase the spread of price difference between the North and South Islands (in dry and wet). 8 November 2011 3 Macquarie Research Meridian Energy Electricity Industry Act: Macquarie Securities has attempted to capture the impact of the physical and virtual asset swaps (VAS) impact contained in the Electricity Industry Act (EIA). We have modelled a three-year progressive ramp-up for the Meridian Energy-GEN 15 year VAS (effective 1 January 2011) to an ultimate volume of 450GWh. We have assumed a three-year progressive ramp-up to the 15-year Meridian Energy-MRP swap to an ultimate volume of 700GWh. The VAS contracts are assumed to have been priced at fair value. On 1 June 2011, Meridian Energy sold Tekapo A and B power stations and related assets to Genesis Power for $820.2m, resulting in a gain on sale of $174.8m. We have stepped down our TOU, SME and mass market volumes over a two-year period in proportion to Meridian Energy’s pre-EIA volume mix. Mean hydrology, operating costs, HVDC/AC charges and capital expenditure forecasts have been adjusted to reflect the sale. Our estimate of Meridian Energy’s target hedge ratio remained unchanged.
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