Company Overview: Meridian Energy Limited (ASX: MEZ) is involved in the business of 100% renewable electricity generation through wind farms and hydroelectricity plants. MEZ facilitates electricity supply to customers from the electricity grid which blends electricity supply from both renewable and non-renewable sources. MEZ has segmented its revenue sources across geographies – New Zealand (89% of FY20 revenue), Australia (10% of FY20 revenue), and the United Kingdom (1% of FY20 revenue).

MEZ Details –

Favorable Outlook from Standard & Poor’s: On 25 May 2021, Standard & Poor’s Global Rating revised MEZ’s credit rating outlook from BBB+/Negative to BBB+/Stable in line with Rio Tinto’s corporate decision to continue operations at New Zealand Aluminum Smelters Limited (NZAS) until 31 December 2024. The decision palliated previously estimated pressure on energy margins and earnings.

MEZ to Build Wind Farm in Hawke’s Bay:  As announced on 24 February 2021, MEZ expects to begin the construction of a NZ$395 million wind farm in Hawke’s Bay. The 176 MW, supported by 41 turbines, is expected to power over 70,000 average households in New Zealand. Constructions’ estimated completion is three years which will, in turn, produce 260 new jobs.

Historical Financial Trend:

MEZ has showcased a sustainable historical performance and has kept its value proposition intact. Although gross margins have declined, they have maintained consistency over the past three years. Revenues have increased from NZ$2,320 million in FY17 to NZ$3,405 million in FY20, reflecting a 13.64% CAGR (FY17 – FY20). Residential energy unit costs and electricity unit costs have approached their ten years and eight-year lowest levels, respectively after adjusting for inflation. In addition, wind and hydroelectricity generation has touched a record high in consequence of higher wind farm availability and inflows of 115% above average.

Figure 1: Five Year Trend Graphs:

Source: Company Reports

Half-year Performance:

During H1FY21, MEZ registered NZ$540 million, in total New Zealand energy margin, down by ~10% PcP. Although retail contracted sales, wholesale contracted sales, and generation spot revenue inclined by NZ$69 million, NZ$10 million, and NZ$27 million, respectively, EBITDAF declined to NZ$422 million (down by ~9% PcP). The primary contributor to lower energy margin and EBITDAF was NZ$154 million higher costs to supply customers as a result of higher customer sales volumes partly offsetting 6% increase in average sales price. During the period, New Zealand power generation declined to 5,911Gwh from Hydro and 765Gwh from Wind relative to 6,408Gwh from Hydro and 779Gwh from Wind in H1FY20, respectively. After reduced EBITDAF and high cash taxes, operating cash flows declined by 30% (reported NZ$187 million) relative to H1FY20.

Figure 2: Financial Performance Against Prior Period:

Sources: Company Reports, Analysis by Kalkine Group

On the Balance Sheet front (as of 31 December 2021), MEZ exhibits strong funding and liquidity position with cash and cash equivalents amounting to ~NZ$122.0 million coupled with economical debt levels. Long-term debt marginally increased from ~NZ$1,374 million on 31 December 2019 to ~NZ$1,408 million on 31 December 2021 and net debt to EBITDAF stood at 2.0x.

Full-year FY20 Performance

Despite COVID-19 discrepancies and subsequent containment measures, MEZ’s financial momentum had exhibit consistency and sustainability. EBITDAF improved by 2% YoY and stood at NZ$854 million due to higher New Zealand energy margins (up by NZ$14 million), Australia energy margins (up by NZ$4 million), and NZ$8 million reduction in transmission expenses with the new regulatory control period, partially offset by NZ$12 million increase in operating expenses. Operating cash flows took a shallow dive from $NZ635 million in H1FY20 to $NZ605 million in H1FY21 as a result of a series of one-off items in operating costs.

Figure 3: FY20 EBITDAF Movement:

Source: Company Report

Top 10 Shareholders: The top 10 shareholders together form ~59.19% of the total shareholding. The New Zealand Treasury and BlackRock Institutional Trust Company, N.A. holds a maximum stake in the company at ~51.04% and ~2.04%, respectively.

Figure 4: Top 10 Shareholders:

Key Metrics: With consistent growth in sales volume across segments has translated to long-term sustainable growth levels. Steady cost of revenue has streamlined profitability, exhibiting a sustainable growth rate across years. Recent COVID-19 turmoil did not have a material impact on MEZ’s financial health. MEZ’s liquidity position has improved while being around industry standards.

Figure 5. Key Financial Metrics

Growth and Liquidity Profile (Source: Analysis by Kalkine Group)

Outlook: On June 2020 Electricity Authority (EA) announced to replace the HVDC charge with residual and benefit-based charges. The decision is estimated to reduce MEZ’s annual HVDC costs from NZ$93 million in FY20 (Actual) to NZ$65 million in FY21. With the new Transmission Pricing Methodology (TPM) in place by April 2023, MEZ's annual HVDC costs are further expected to nosedive at NZ$39 million levels. To dilute reliance on NZAS, MEZ’s development of NZ$395 million wind farm in Hawke’s Bay and completion of the Clutha Upper Waitaki Lines project by May 2022 will build generation capacity and diversify the project portfolio.

Key Risks: Power projects are typically susceptible to high operational and regulatory risks. In addition, climate change and weather conditions play a significant role in renewable energy generation. With high debt levels in place, significant movements in interest rates may abruptly impact MEZ.

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

Stock Recommendation: MEZ has delivered 3-month and 6-month returns of ~-9.159% and ~-23.101%, respectively. The stock is trading below the average of the 52-week low price of $4.160 and the 52-week high price of $9.330, indicating an accumulation opportunity. We have valued the stock using the EV/Sales multiple-based illustrative relative valuation method and have arrived at a target price of low double digit-upside. We believe that the stock might trade at a premium compared to its peer average EV/Sales (NTM trading multiple), considering stable operating expenses, improved cash position, and sustainable operating cash flows after one-off expenses. For this purpose, we have taken peers such as Mercury NZ Ltd (ASX: MCY), AusNet Services Ltd (ASX: AST), New Energy Solar Ltd (ASX: NEW), to name a few. Considering the prompt balance of power generation and sales volume, asset portfolio diversification, dominant liquidity position, current trading levels, and valuation, we give a “Buy” recommendation on the stock at the current market price of $4.860, down by ~2.214% on 16 June 2021.

MEZ Daily Technical Chart (Source: REFINITIV)

Note: The upper 2 yellow color lines denotes Resistance 1 and Resistance 2, while the lower 2 yellow color lines denote support 1 and support 2.

Technical Indicators Defined:

Support: A level where-in the stock prices tend to find support if they are falling, and downtrend may take a pause backed by demand or buying interest. 

Resistance: A level where-in the stock prices tend to find resistance when they are rising, and uptrend may take a pause due to profit booking or selling interest.

Stop-loss: It is a level to protect further losses in case of unfavourable movement in the stock prices.

Note 1: The reference data in this report has been partly sourced from REFINITIV

Note 2: Investment decisions should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the analysis has been achieved and subject to the factors discussed above alongside support levels provided.