AER's Final Decision for Transgrid for next regulatory period
The AER released its Final Decision regarding Transgrid's regulated revenues for the five year regulatory period running from July 2018 to June 2023. Initially, the AER is allowing Transgrid to recover $4,015m of total regulated revenue across July-18 to Jun-23. Excluding contingent projects, we expect total revenues will be approximately 3% less than this, as the annual update of the trailing cost of debt will likely pull down the WACC and thus allowed revenues. This is because the current cost of debt (say mid-4% per annum) is lower than the 6% per annum trailing average cost of debt currently in the WACC formula.
Four features of the Final Decision are:
- the initial WACC allowance was effectively unchanged compared to the Draft Decision at 6.5% per annum (including 7.4% per annum return on equity);
- an increase in the capex allowance compared to the Draft Decision providing funding for critical projects, such that RAB growth across the cycle will likely be approx. $285m stronger than we had previously modelled;
- the AER has indicated that Transgrid's opex proposal is reflective of efficient costs; and
- identification of nine contingent projects which will be included in the capex allowance if trigger events occur.
Reflecting the Final Decision adjusted for a forecast declining cost of debt allowance, our Transgrid modelling has higher capex, RAB roll-forward, and revenues than previously. We also update the assumed cost of new debt, which results in lower effective interest rates and lower regulated revenues (via the trailing cost of debt annual adjustment). Net increase to Look-through Operating Cash Flow across FY19-25F is 0.2-0.6 cents per share.
Our sum-of-the-parts valuation (and share price target) nudges up 3 cents per share (Morgans clients can login to view our share price target and our detailed SKI report).
Our positive view on Spark Infrastructure (SKI) is based on a sector-high yield of 7.4% (based on FY18 DPS guidance), valuation support, high quality assets and takeover potential.
Our enthusiasm is partly tempered by heightened regulatory risk arising from the AER's reviews of its WACC guidelines and its cost of tax allowances framework (both due June 2018). The outcome of these reviews won't impact SKI's earnings until the start of the next regulatory cycles (first will be SAPN applicable from Jan-21), but could be meaningful to valuation. The seemingly complex tax structures employed by SKI heightens the tax risk, but an extreme approach of removing all tax allowances from our revenue modelling negatively impacts the valuation by approx. 25 cents per share.
We retain our Add recommendation.
Morgans clients can login to view our detailed report and share price target for Spark Infrastructure (SKI). Alternatively, please contact your Morgans adviser or nearest Morgans office for access.
Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.