NEW ZEALAND Meridian Energy 13 June 2008 Performance evaluation Meridian Energy equity valuation Macquarie Research’s discounted cashflow based equity valuation for Meridian Energy is $4,540m (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 The 12 month ($4,592m) and 24 month ($4,629m) target valuations for the Inside company have been derived by rolling forward the discounted cashflow model 12 and 24 months respectively and deducting from these values the forecast Performance evaluation report 2 12 and 24 month dividends to the Crown. Valuation summary 6 Financial model assumptions and commentary Financial model assumptions and We have assessed the sensitivity of our equity valuation to a wide range of commentary 10 inputs. Broadly, the sensitivities are divided into five categories: generation assumptions, electricity supply, gas supply, financial and price path. Financial statements summary 17 Meridian Energy historic and forecast We highlight and discuss a number of key model input assumptions in the report: performance 20 Financial flexibility and generation ⇒ Meridian Energy’s generation development pipeline; development 21 ⇒ The company’s retail and SME pricing position; Alternative valuation methodologies 22 ⇒ Other long term contract hedge pricing; ⇒ Wholesale electricity price paths; ⇒ Arc Innovations metering technology. Historic and forecast performance versus SCI We have analysed the spread between Meridian Energy’s return on funds and its WACC to gauge its historic and forecast financial performance; Going forward, Macquarie Research forecasts that Meridian Energy will average a -2.1% return over WACC over the next five years (FY08-12); Beyond FY12, Macquarie Research expects Meridian Energy to yield steadily increasing excess returns, largely as a result of increasing margins on its hydro and wind generation as wholesale electricity prices track towards a LNG parity price in 2020. 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. Analyst Stephen Hudson 649 363 1414 [email protected] 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: 2452719: v2 Macquarie Research Equities - Report Meridian Energy Performance evaluation report Meridian Energy equity valuation Macquarie Research’s discounted cashflow based equity valuation for Meridian Energy is $4,540m (nominal post tax 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 ($4,592m) and 24 month ($4,629m) 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 Meridian Energy WACC. Alternative valuation methodologies We have assessed a sum of parts valuation for Meridian Energy based on reported transaction asset multiples. The equity value range assessed is $10,001–12,668m – a range which lies well above the 12 month DCF based equity valuation target of $4,592m. We note that applying European benchmarks to value existing and pipeline generation assets should only be seen as something of a reality check on the DCF based equity valuation. EV/installed capacity metrics will vary substantially with capacity factors, plant age, distance to load etc. Overall, we think 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 the former and also due to the price discounts embedded in the Comalco supply contracts. 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: Development pipeline. The company has proposed a number of greenfield wind and hydro generation developments totalling in excess of 1,200 MW (excluding Mini Aqua). These projects are not included in our financial model and DCF based equity valuation. They are recognised in the alternative sum of parts valuation methodology. Retail and SME pricing. As at May 2007 Meridian Energy was pricing its mass market electricity volumes at an approximate 7% premium to the average market pricing – down from an approximate 14% premium two years prior. This premium pricing may well reflect the company’s HVDC transmission cost impost and possibly its summer generation bias. We have attempted to back out Meridian Energy’s commercial/SME fixed pricing through an earnings reconciliation. Our valuation for the company is sensitive to this variable given its approximate 15% share of company generation volumes. Average commercial/SME pricing for the company is estimated to be 17.1c/kWh for FY08 – not markedly different to the published average commercial pricing. 8 Aug 2008 2 Macquarie Research Equities - Report Meridian Energy Comalco supply contract renewal and pricing We estimate that 4,821 GWh (38% of total forecast generation volumes) of energy will be sold to Comalco NZ for its Tiwai Point aluminium smelter under a number of long term contracts which expire in 2012. In October last year, Meridian Energy and New Zealand Aluminium Smelters (NZAS) entered into an electricity price agreement (as distinct from the prevailing supply agreements) in respect of 572MW of consumption at the smelter. Base pricing (not disclosed) is subject to escalation with reference to the market price for NZ electricity, the world price for aluminium and an inflation component. Macquarie Capital has assumed that these escalation components are weighted approximately equally. Both our base cases (1 and 2) assumed that the prevailing contracts would be renewed and that the pricing under the contracts will be approximately 52% of the price implied by forecast wholesale prices by 2012. Our DCF equity based valuation is highly sensitive to this assumption. For every 5ppt discount to forecast wholesale prices we incorporate in the Comalco contract pricing (including the assumed post 2012 renewals), the equity valuation moves by around $184m or around 3.3%. 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 FY08. We have assumed that these volumes are priced in line with forecast wholesale prices. Given an upward wholesale price path, this assumption implies that pricing is at a small discount to expected forward prices. For every 5ppt discount to forecast wholesale prices, the equity valuation moves by around $105m or about 1.9%. 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 Arc Innovations 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 (mid-point) in the company’s alternative sum of parts based equity valuation. Historic and forecast performance versus SCI We have analysed the spread between Meridian Energy’s return on funds employed and its WACC to gauge, broadly, its historic and forecast financial performance. In this regard we make the following observations: Meridian Energy has averaged annual returns of around 8.1% pa over the past five years, 1.1% lower than its cost of capital (based on a post tax nominal WACC of 9.17%). Historic performance has been reasonably volatile ranging from a 1.3% excess return over FY05 to a negative return to WACC of 3.4% over FY07. The variation of returns appears to have been driven by a combination of the 30 June 2003 generation asset revaluation, the acquisition in late FY03 of Southern Hydro and low hydro inflows over autumn 2004. Over FY05, the company benefited from relatively strong retail pricing (ex lines charge increases) and a strong Southern Hydro result. Going forward, Macquarie Research forecasts that Meridian Energy will average a -2.1% return over WACC over the next five years (FY08–12); Beyond FY12, Macquarie Research expects Meridian Energy to yield steadily increasing excess returns, largely as a result of increasing margins on its hydro and wind generation as wholesale electricity prices track