Share price strength
Since the heightened market volatility that commenced in August last year, AusNet Services (AST)(+12% Total Shareholder Return) has outperformed the broader market (flat) and its energy infrastructure peers (SKI +1%, APA 0% albeit impacted by failure of CK's takeover bid). We think the share price is being driven by falling government bond rates, and a switch from SKI to AST given SKI's tax issues (AST is a normal tax payer) and reduction in its FY19+ DPS outlook.
= Compressed potential returns
At current prices, we estimate potential 12-month return of approximately 3% based on our revised share price target and including a 5.4% cash yield (franking in FY19 is expected to be 40-50%). At approximately 1.31x, the EV-to-Regulated and Contracted Asset Base ratio is approaching historical highs.
Looking longer term, we estimate a five-year investment return of approximately 6% per annum, based on our distribution forecast and five years-out valuation. This reflects limited valuation growth, as we think regulatory outperformance will become tougher to achieve, and recent regulatory decisions (rate of return guidelines, regulatory tax) and stubbornly low bond rates impact medium-term cashflows.
AST's capital management strategy balances the funding of significant capex, achieving key credit metrics required of its A- credit rating, and paying distributions to investors.
Even after assuming drip feed of new equity via an ongoing DRP, our forecasts suggest downward revenue pressures and expiry of the hybrids' 50% equity credit period in FY22 causes credit metrics to breach the downside trigger required for the current credit rating. As such, we have assumed zero DPS growth in FY20, and then a decline in FY21 as the next Electricity Distribution cycle commences. We suspect further remedial action may be required to restore a buffer over the downside trigger level. The staggered nature of AST's regulatory resets (Electricity Distribution January 2021, Transmission in April 2022, Gas Distribution January 2023), unexpected strong outperformance of regulatory assumptions, and incentive revenues could be the saviours.
Minor positive EBITDA change for FY19-21F. FY22F EBITDA lifted as we re-profile the Electricity Distribution smoothed revenue allowance at the next reset by assuming a first-year step-down then CPI growth through the remainder of the cycle. We also assume residual cash is dedicated to debt paydown, assisting credit metrics.
Next key events
The FY19 result is due 13 May – we expect earnings decline and our forecasts are below consensus. We expect this will include first-time FY20 DPS guidance – we assume AST will keep the DPS flat.
The next key regulatory filings are the initial proposal and subsequent Draft Decision for Electricity Distribution in July 2019 and March 2020 respectively. The Draft Decision for SA Power Networks due September 2019 may provide important insights for the Electricity Distribution decision.
Following recent share price outperformance, and given the compression in total potential return, we downgrade our recommendation from Add to Hold.
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