1H17 result summary
The 1H17 result was a mixed bag, with +18% EBITDA growth from SAPN (ahead of expectations). The EBITDA decline from VPN (-13%) missed our forecast while the EBITDA decline from Transgrid (-15%) beat our forecast. Free cash flow across the assets declined, but to a lesser extent than we had expected given the outturn of capex.
Asset distributions to SKI were less than expected, mainly due to the materially reduced Transgrid distribution.
Regulated revenue growth expectations for SAPN/VPN (3-5% pa CAGR for next three years) are relatively predictable under the revenue cap regulation. Solid unregulated earnings continue to be contributed by VPN and SAPN at low capital intensity. The unregulated connection base at Transgrid continues to be expanded, albeit at higher capital intensity (but more certainty) than VPN/SAPN's unregulated earnings. Each asset company is pursuing efficiency/cost-out programs. Effective interest rates on debt continue to track lower, as a result of attractive refinancings and locking in swaps at lower rates than previously. The gearing of SAPN/VPN is below target, providing capacity to fund capex and distributions.
Distribution guidance was reaffirmed at 15.25 cents per share for FY17 and 16.0 cents per share for FY18.
While lower than expected capex improves free cash flow and reduces debt, when it is (substantially) below the regulatory allowance (and our forecast) it results in a lower roll-forward of the Regulated Asset Base (RAB). This issue, which is accentuated by the current low CPI inflation, ultimately leads to lower regulated revenues during the next regulatory cycle (all else held constant) and lower long term value (teed off the RAB).
Large working capital movements and non-cash items seen in the results reduce the predictability of cashflows. Transgrid is having to fund relatively small amounts of unregulated growth capex with equity cashflow (resulting in less distribution to SKI), due to gearing constraints imposed by Moody's and the asset lease with the NSW Government. The 1H17 dividend per share (DPS) was not covered by operating cash flow, albeit guidance is for full coverage of the FY17 DPS.
Forecast and valuation update
We had been conservative on our SAPN interest cost and unregulated revenue assumptions, seeking proof of sustained performance. The 1H17 result has enticed us to improve our forecasts for these two items, which is the key contributor to the upgrade to our share price target. It also contributes a 6-8% increase in look-through asset cashflows. We leave our DPS forecast unchanged, aligning to guidance for 2017/18.
There is asset value on a standalone basis, with Merger & Acquisition upside risk. We retain our Add recommendation.
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