Full Year 2020 Mercury NZ Ltd Earnings Call
Auckland Aug 18, 2020 (Thomson StreetEvents) — Edited Transcript of Mercury NZ Ltd earnings conference call or presentation Monday, August 17, 2020 at 11:00:00pm GMT
TEXT version of Transcript
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Corporate Participants
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* Vincent John Hawksworth
Mercury NZ Limited – CEO
* William Meek
Mercury NZ Limited – CFO
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Conference Call Participants
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* Andrew Rupert Pelham Harvey-Green
Forsyth Barr Group Ltd., Research Division – Director & Senior Analyst of New Zealand Equities
* Grant Swanepoel
Jarden Limited, Research Division – Research Analyst
* Nevill Gluyas
Jarden Limited, Research Division – Director of Equity Research
* Stephen Hudson
Macquarie Research – Head of Research
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Presentation
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Operator [1]
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Ladies and gentlemen, thank you for standing by, and welcome to the Mercury annual results briefing.
(Operator Instructions) Please be advised that today’s conference is being recorded.
I’d now like to hand the conference over to your speaker today, Mr. Vince Hawksworth, Chief Executive.
Thank you. Please go ahead.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [2]
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Thank you, operator. And welcome, everybody. It’s a privilege to take my first Mercury results presentation since joining the company in March.
I’m joined on the call by William Meek, Chief Financial Officer. And obviously, William will be well known to all of you.
So if we turn to Slide 3, I’ll just briefly touch on myself in this new role. As it says, I started on the 30th of March, in COVID level 4 lockdown; and that was a pretty unique experience made better by the fact that Mercury has a strong team and a capable team. My background, obviously well known in the New Zealand energy sector, previously with Trustpower and Genesis and at Hydro Tasmania. So a long background in renewables and a long background in wind.
I guess the first thing I’d want to say is that Mercury has transitioned really well in response to the COVID-19 lockdown, both the one we had in March but also in the most recent one, ensuring that we’re operating our plants safely and delivering reliable and secure generation for New Zealand through our assets, through our renewable assets, both geothermal and hydro, and looking after our customers. We’ve got a passionate group of people in the company. They are really clear about what it takes to achieve. It’s pretty clear, though, that we are living in a really changed world. And I think those who are going to be successful in the future are those who can adapt and reform their business processes around the challenges that we see. And we are very positive about what we can do as a [essential provider] for our customers, for our stakeholders, looking after our staff along the way, and therefore delivering for our investors.
So if we turn to Slide 4, we’ll talk a little bit about the highlights, which I would characterize as a really strong result in what has been challenging times: a good EBITDAF performance at $494 million, which whilst it is down compared with FY ’19, it reflects really challenging hydrology in the second half of the year particularly and also the sale of Metrix last year. And it reflects really the underlying strength of our portfolio of North Island-based geothermal and hydro and a really effective customer business. As I’ve touched on, the lockdown response was positive. Obviously, we had challenges with respect to our Turitea wind farm, which we had to stop work at. And we also stopped some drilling work for our geothermals. Those businesses are back up and running, and we look forward to successfully completing Turitea in due course. One of the things that became really self-evident in the lockdown was the ability to respond to customers’ needs. We have very successfully, I think, managed some of those difficult conversations with customers and been able to do that from home. And it really leads the way for our continued opportunity to digitize and grow on the back of a strong platform.
Our ordinary dividend declaration, I think, reflects the belief we have in our company and represents the 12th consecutive year of ordinary dividend growth. We were also able to complete major refurbishments at Whakamaru and Aratiatia with some staff working through the lockdown 4 to ensure that, that plant is back on to deliver through the winter period. We’ve already set ourselves up well with this refurbishment program for the future with [really a] strong asset base. And as I said, the Turitea wind farm has continued to progress.
So that sort of gives some highlights. I’m going to pass to William, who’s going to talk through some of the details of the financial performance and portfolio response.
So I hand over to you, William.
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William Meek, Mercury NZ Limited – CFO [3]
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Thank you. Thank you, Vince.
So we’re now on Slide 5. Certainly, welcome again to those on the call today, very pleased to be presenting the results for FY ’20 for Mercury. And again, a very warm welcome to Vince, our new CEO. I mean (inaudible) presenting results, but it’s been great to see him pitching for Mercury’s performance during FY ’20.
So just some highlights here on the financial performance chart. We can see energy margin down slightly at $652 million for the year, again [an admirable] performance given 376 gigawatt hours lower generation with prices, wholesale prices, well north of $100 for the year. So really reflecting a strong performance across the generation and customer business. Certainly, our big focus this year, given the drought condition, is around hydro generation, lake management, our customer mix and pricing, some really good geo work results and some strong performance in heating and training across the business.
Operating expenditure down $9 million to $190 million. Again, once we adjust for Metrix and IFRS, we’re broadly in line with where we’ve been for a number of years. EBITDAF performance of $494 million, quite a bit above our guidance we issued in June, which was signaled at $480 million. We did have a late adjustment to Tilt, having worked through that with our auditors, better signaled quite clearly in terms of the bargain purchase in our accounts. So an $18 million bargain purchase there. And I think we would forecast [to hit a $5.5 million] or $6 million uplift in that guidance. So that largely explains the delta between guidance and the final printed $494 million EBITDAF.
NPAT, again down significantly to $207 million largely on the back of the $177 million gain on sale of Metrix last year. Underlying earnings, again comparable to the year before, up $3 million to $164 million, really reflecting a — lower interest costs and certainly tax expense also.
Free cash flow, [we’ve got a] pretty simple bridge between the $272-odd million and $242 million in FY ’20. We did see sort of core — slightly lower core operating cash flow. So it’s payments to suppliers and receipts from customers down about $17 million. We did see higher CapEx of $25 million you can see in the next bar and certainly a $10 million reduction in cash interest costs largely explaining that bridge from $270 million to $240 million. We had a high capital expenditure year in terms of stay in business at $114 million. Again, that was in line with guidance to the market, reflecting completions of major refurbishments at Whakamaru and Aratiatia and also a 3-well drilling program at Kawerau and Rotokawa.
Growth investments ticked up. In Turitea, we saw $165 million or, I think, $164 million actually put into Turitea during the financial year, taking life-to-date spend up to $184 million at Turitea, well up on the $81 million in the FY ’19 year which was driven again by that $55 million bond, $55 million term bond, on equity raised in the remainder and at the start of the Turitea project. And as Vince has said, ordinary dividend up $4 million to $215 million.
So a good performance. And certainly, as we look forward to ’21, as the release says, we certainly are focused on building the resilience, productivity and efficiency of the firm, so that will be a ongoing focus as we move through this financial year and beyond and deal with the challenges of the Tiwai exit [and these] COVID-19.
Now moving to Slide 6, a quick earnings bridge from ’19 to FY ’20. Again we’ll step through this fairly quick. Sale of Metrix in terms of normalizing last year’s earnings or EBITDAF reduces that to $486 million. Significant generation volume decreases. [So we’ve seen that] 376 gigawatt hours down at a GWAP of $110 a megawatt hour. Prior year saw GWAP of $139, so quite at sort of lower wholesale prices but still elevated relative to prices we observed pre October ’18 with those gas field outages. So quite big impacts in terms of loss of generation volumes through the drought and obviously lower revenues due to price. Obviously, you get a compensation when you go to the customer side of the business. You’re seeing the opposite. You’re seeing a saving in terms of purchase costs of almost $140 million; and the lower volumes, so 160 gigawatt hour lower volumes of FPVV, again reducing those purchase costs. Those have been essentially offset by lower sales, obviously more amount, and then price. Certainly C&I yield is up in [index markets, with price lift] returns about $24 million.
Moving to our derivative book, which did grow about 250 gigawatt hours between FY ’19 and ’20 to 3,400 gigs. Again a short derivative book with lower prices seeing some strong positive movements up in both end-user CFD markets and other derivatives. So bridging through takes us through to the headline number of $494 million.
I’ll hand back to Vince on Slide 7.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [4]
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Yes. Thanks, William.
So on Slide 7. I think the really important thing as an incoming Chief Executive to Mercury is thinking about the overall direction, particularly in a world where we obviously are having these COVID-19 impacts and the way that they’re playing out in our sector. And I think the direction is robust. At a high level, this focus on these 5 pillars of commercial outcomes, customer outcomes, the partnerships, the people and the kaitiakitanga turnover, the way that we think about things in a long term is totally appropriate. And you’ll certainly, over the coming year, see us talking more and more about the need to really ensure that we’re a match fit for the period that’s coming.
So I think, if we then turn to Slide 8, which has some of the key performance indicators around these pillars. We’re feeling positive about the position of the Mercury brand. And our Net Promoter Scores would indicate that those customers that are experiencing Mercury are having a positive experience. However, we’re under no illusions that — as we transition through the period of Tiwai exits and COVID-19, it will be about delivered and particularly delivery to customers across the spectrum. So having the background strength as a good starting platform, we will be very much focused on resilience and efficiency.
If we look at the partnerships bar. Mercury has had a long history of working well with others, whether that’s our suppliers or iwi or other relationships in the community. And we’re very proud of how that’s worked. We will have to dial up those relationships as we look to continue to manage the fallout from lockdown, and this will be a key focus. From a kaitiakitanga perspective, William mentioned the LWAP/GWAP outcomes. And I think it’s really important to understand that the sort of refurbishment that the company has been doing on its hydro assets like Whakamaru, like Aratiatia is increasing that ability to manage peak pricing to be able to move water down the Waikato River system. This is critically important. And again, as the industry transitions, it’s we need to think about the Waikato River chain as New Zealand’s best peaking station. And the great thing about that is, as we move through that, that we can continue to reduce our emissions intensity.
No business can operate without great people. And Mercury is fortunate to have a lot of very passionate staff who actually care about what we achieve. Whilst our health and safety incidents — unfortunately, we had a lost time injury last year that we were very disappointed about. Our focus is on safety first before any of the other things that we do. And if we do that and we maintain strong employee engagement, then I think we can continue to look at productivity as a lever that we can pull within the business. And certainly, that is a big focus at the moment is how do we increase resilience and productivity in the face of the headwinds of the environment that we’re operating in. And then that turns us to the commercial bar, which we have some levers in there that we’re able to push in the sense that we’ve already signaled where we see FY ’21 coming out. And we have the benefit of completing Turitea, which brings more gigawatt hours that we would be able to manage in our portfolio by judicious use of the Lake Taupo battery.
So I think we feel positive and excited about the future. However, if we turn to Slide 9, we’re not complacent. COVID-19 was a difficult period for New Zealand. It is a difficult period for New Zealand industry; and it’s been a difficult period for many, many of our customers. We’re pleased about the way we’ve transitioned, and I’ve spoken about that from an operational point of view. We did see that demand during that first lockdown period reduced but particularly — it particularly reduced around commercial demand. In the medium term, we know that in this, [departing] New Zealand and the pressures other large industrials are under, is going to create a period of great uncertainty, and we need to adapt and learn so that we can be successful in the future. We’ve worked quite closely with customers. Mercury has not just the customers that deal with us through sort of the normal processes of being a retailer, but we also have the [global product]. And what we found through lockdown is that, by increasing communication with customers, working closely with them, we’ve been able to manage their exposure to debt reasonably well, but again we are very, very aware that, over the next year to 2 years, New Zealand customers will come under pressure.
As I mentioned earlier, we have had to put Turitea on hold through the initial lockdown. We have successfully restarted. Now whilst we are facing some delays to that project, I can say that the work that has been done is looking good and that it will not be too long before we start to erect turbines on the foundations that have been laid. So we’re feeling excited about what will be New Zealand’s largest wind farm and the additional gigawatt hours that will add to our portfolio.
So if we move from Slide 9 to Slide 10, I’ll hand over to William, who can talk a little bit more about the low inflows we’ve experienced.
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William Meek, Mercury NZ Limited – CFO [5]
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Thank you, Vince.
So just on the COVID lockdown response. This is Slide 9. We certainly had a smooth transition to working from home. Certainly, IT investments over the previous couple of years put us in very good stead. Certainly, the move to 33 Broadway and flexible working saw us very smoothly transition to full service from home with very few exceptions. We had a couple of our traders still operating out of the office not because of necessity. It’s just much easier when you’ve got a [20-spring setup] to run a lot of power stations, but — and key maintenance happening on site. Certainly our internal survey has said, as soon as — the vast majority of people reported greater productivity while working from home. So that was certainly encouraging (inaudible) remained normal. And as been said, certainly the focus on customers was very high.
Demand. As you would be aware, demand certainly was down during a little bit before lockdown but has recovered to some of the levels in earlier of the year. So certainly demand peaks have been high, and we’re still seeing very high wholesale prices in the market coinciding with [colder cold] conditions in recent days. Certainly, as we look forward — we pick the papers up today and again read about New Zealand still, in the refinery, thinking about the future, is obviously affected significantly by the global downturn. A big focus around helping customers manage their bills. And so certainly, at year-end, we were not experiencing material changes. And again given the government support for wage subsidies and additional benefits, Winter Energy Payment, we’re certainly seeing most — the vast majority of our customers are managing their balances well and certainly a very proactive approach from our retail business in engaging with customers to help them work through those issues.
On hydrology, this is Slide 10. I’ll just quickly talk to this chart because it’s quite complicated. The gray-shaded areas show the minimum or maximum level of Lake Taupo over the last 20 years or so. You can see a big white area between November and February. You do not want to have the lake low going into summer because the dry period for us traditionally is late summer, early autumn. And you can see [all mills, all factors], the sequences fall down. So you really do want to have the lake up near the top as you go into that sort of Christmas, New Year period, which is really important.
So as we said, I think we’ve experienced about a 12% of inflow sequence for FY ’20. It’s near-record low from September; and that has continued into FY ’21, the July — dry July. And for contrast, the South Island (inaudible) inflow event last financial year, so FY ’20. So quite a contrast between the North and the South Island in terms of rainfall. So I’ve already said certainly lake management, how that impacts the portfolio is key. So that is how we manage that lake as a key factor in managing both wholesale market opportunities and exposures. So being able to get the lake near the top of the operating range by the end of December certainly put us in good stead in terms of generation and supporting the portfolio as we roll through a particularly dry 6 months for the second half of FY ‘20.7
And so certainly the team has done a fantastic job in terms of managing those risks at a time where prices were generally elevated but certainly, you can see, fell away during the height of the lockdown in April with prices dropping below $48. So again, we see that as key strengths in terms of Mercury managing the lake. It’s not a big lake. It’s only 600-odd gigawatt hours between the top and the bottom, so it’s quite different to some of our — some of the lakes in the South Island, but that in combination with your retail portfolio settings and hedging through the year, again, manages those price exposures and opportunities in the market very well.
So turning to Slide 11, looking at retail tactics. This is a familiar chart here on the right showing the switching levels, both gains and losses by month. And you can see the lines at the top and the bottom reflect the level 12 months earlier, so you can do a PCP comparison. So something that’s quite stark is — in these charts is you can see that the level of acquisition activity has absolutely reduced for Mercury and particularly since October ’18. So with the elevated wholesale prices, the company has made quite key decisions around its willingness to acquire customers through discounting or lower pricing. And so that really feeds to the yellow line on the second chart showing how our proportion of acquisition and customers has changed from around half — the middle of ’18, coming online with — effectively quite on acquisition rates. And now you’re seeing essentially all customers are coming on either on a term contract or on headline rates with some form of incentive. So that’s really designed to avoid that very horrible moment of truth in the future when you’re looking to increase prices. And obviously, customers generally react badly to large price increases and either leave or essentially demand further rate reduction. So that has been quite a target.
You can see Farm Source there in July — in June and July, August, fixed gray spikes. So that’s the 8,000 customers. Again, a very deliberate decision to let that contract go. And so again reducing customer numbers but also making a decision against wholesale prices and C&I yields. This isn’t to trade some mass market volume for C&I volumes. So some quite strong yield growth there. You’re seeing mass market is up 3%; C&I yields up over $7, almost 9%, versus the prior year. So again quite a focus in terms of just the returns across that customer business. Certainly, as we look forward with Turitea coming online later this year, we will need to work through what channels that volume will be sold into.
Turning now to Turitea on Slide 12. We’ll work through this quite quickly. So the — just explaining the 2 types of contracts that exist on the site. We do have a full EPC contract with Vestas. So they are the head contractor. So that is a fixed-price contract. And we have seen a delay there. So we’re signaling completion of the northern 33 turbines late this financial year. We certainly have seen delays triggered by the level 4 lockdown shutting the site down for over 30 days, but also we have seen some challenges around design and (inaudible) on the site.
The offshore procurement. So this is the blades, the towers themselves. They’re all largely unaffected by COVID-19. So all the — almost all of the equipment for northern zone is — are in the country now. So for those visiting [Plymouth North] or be — drive down [on that particular line], you’ll see a whole lot of wind blades there in the town currently stacked up, ready to be taken up to the top of the hill. The southern zone, 27 turbines, we’re expecting to see completion later in calendar year ’21. Of course, those are [getting for beds. We go back [into them] a little bit before the site being shut down again. It’s not an essential service designation at the moment, so therefore certainly purely COVID-19 restrictions could impact timing on the site.
[To touch a bit on the] transmission poles. So certainly that’s a design-build contract with Electrix. It’s well advanced, but we have seen again some delays there. And that will be complete late in calendar year 2020, but that’s not on critical path at this point. Transpower has completed its connection works through the Linton substation. So it’s that project has gone well.
Vince, if you…
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Vincent John Hawksworth, Mercury NZ Limited – CEO [6]
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Thanks, William.
So if we turn to Slide 13. I suppose the — so many of you are aware I have some history of the Tilt investment. And what it does provide to Mercury is exposure to another marketplace, a marketplace where currently only 24% of generation is renewable and has in the long term to make this transition to more renewables. So from that point of view, it’s a very positive investment. It’s provided that exposure to decarbonization in Australia. We’ve benefited from the capital return of $55 million in July. And the investment has been a good one for Mercury, with it now being worth $274 million.
Yes, Tilt is currently completing the Dundonnell wind farm, and that is gradually coming online now, but probably most importantly it has a strong and positive pipeline of opportunities which are available to be monetized as conditions in Australia allow. So again it does give us another string to our bow as Mercury.
If we turn to Slide 14 to Slide 15 and we start to think about, well, what does the future look like. The graph there clearly shows the impacts of the announcement of a New Zealand aluminum smelters planned exit next August, August ’21; and shows the futures — how the futures market dropped; and clearly also shows the separation between the Otahuhu mode and the Benmore mode as a consequence of that. So that really reflects the fact that water in August next year will be trapped at the bottom of the South Island. And that increases basis risk and likely increases the competitive environment in the South Island by comparison to the North Island.
With demand continuing to be limited by the economic downturn and the continued risk of further de-industrialization, so uncertainty around New Zealand steel and the refining company, we can expect that supply-demand balance to be disrupted. From a Mercury point of view, we can think about this as on the positive side is the way that the portfolio is managed. Our exposure to the North Island, plus our approach to contracting are — likely puts us in a good position through FY ’21. However, we also have to think about the types of responses that might occur.
So if we turn to Slide 16. And there we can see that Tiwai represents some 13% of New Zealand’s national demand. In order to get that water out of the bottom of the South Island, that 5 terawatt hours down there, the first thing that needs to happen is to debottleneck, if you like, the bottom of the South Island. So in some ways, we can think about the period from now in 3 phases: the phase 1 now to when the smelter actually closes, let’s assume 31 August next year; a phase then between that and when the Clutha and Upper Waitaki line project is completed; and then the phase beyond that. So over the next 12 months, of course, supply and demand will largely be driven quite normally. We would expect to see continued volatility driven by hydrology. And we would also expect to see decisions being made by thermal generators as to how they’re going to respond to the change of supply in the market. When the Clutha, Upper Waitaki lines project releases water from that bottom part of the South Island, of course then the bottleneck is shifted northwards. Now whilst the HVDC can shift the volume of water, the timing of that water being shifted will be the major challenge. So we expect there to be continued volatility in the North Island with periods, potentially overnight, with low demand and prices dropping; and periods — peak periods when that is both dry and calm, where prices will get quite peak-y. So management and volatility becomes a clear portfolio challenge, and we would believe that Mercury’s asset base is well positioned for that.
There’s been a lot of discussion about what are the right things for new — the New Zealand sector faced with these changes. And that includes the idea of large storage at the bottom of the South Island, but I think what really needs to happen, as governments, regulators and participants start to reflect, we need to look at both supply-side and demand-side issues. So supply-side issues will be about managing volatility, whether a South Island storage or a North Ireland pump storage is better, how batteries become part of that choice and how thermal retirements plays into that picture. On the demand side, of course, it would be a lot better to be using the energy closest to where it’s being generated. So the government response and the general response to the fact there will be surplus energy at the bottom of the South Island is important. And there are various things that have been mooted as a way of using some of that energy, but also to think about the transport sector and the process heat sector, particularly in the South Island where the opportunity is to displace coal, that’s I think also a really important debate to be had over the coming months.
So we’re in an interesting position, and to go into that a little bit more deeply, I’m going to pass back to William on Slide 17.
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William Meek, Mercury NZ Limited – CFO [7]
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Thanks, Vince.
So I won’t labor this because this discussion around in this exit and closure is really [well canvassed]. However, certainly the consideration of issues that it presents are very complex. So while [the hearing] here says that spot price outcomes are dependent on transmission build and federal response, certainly those are sort of key ones, there are certainly another of — a number of other variables that certainly could have a profound impact on pricing both in the spot market and then flowing through to wholesale and end-user markets. I think in previous presentations certainly we’ve discussed that generally market is quite challenged when you [price at] very high levels of renewability. There’s no shadow pricing provided by a similar plant in that case. And certainly we’re expecting to see that with the — still in the Lower South Island before that Clutha line is upgraded. And so you’ll have 100% renewable down there and [hydro generations] filing — falling before dispatch. So expect to see very, very low prices under that scenario.
Certainly with transmission constraints affecting particularly the South but also feeding through into the North Island, the hydrology becomes much more important. So with years — and certainly with South Island, the year has become much more challenged in terms of actually moving net water through-wise and through the North. Certainly, there are some questions about what the basis might do between islands, not just because of North Island reserve pricing. And certainly we’re hearing talk of large battery installations proposed by a number of industry participants. They’re certainly good for reserves, but they’re not so good for capacity or energy. So certainly while basis will remain quite a big issue, it’s still unclear how effective South Island generation will be to hedge customer sales in the North Island. It’s still not clear how the thermal operators will either rationalize or operate their plants while those transmission upgrades are being undertaken. And so certainly for — those issues will be certainly worked through FY ’21. What we can see, though, is certainly these actually busy periods here. They show you that it’s hard to get a whole lot more megawatts through to the North Island during peak periods. So they traditionally coincide with the highest prices. So that’s you’ve got a lot of headroom in the [DC] but on off peak. And so that’s certainly interesting when you start thinking through what that might mean for spot price outcomes between the North and the South Islands. And certainly, as you saw in the previous slide, the futures prices through FY ’22, ’23 are signaling sort of mid 70s, low mid-70s; with the South Island [underpinning] more below $50. There is no doubt that the impacts are felt more acutely in the South than the North.
Just touching on demand on Slide 18. Demand closed at just over 40 terawatt hours for the country in FY ’20. It’s down about 1%. And again we’re seeing a pretty average response across most of those sectors, with industrial leading the charge, and I suspect slightly more to come. So we did see potline 4 out. So that by itself is a 45-megawatt load decrease on the prior period, and certainly drought having an impact. And we did see an increase in load due to the low rainfall during the year, but again — so demand fairly challenged over the period, lockdown obviously affecting it but also just a general malaise around outlook given COVID’s impacts globally and affecting export-led markets.
I’ll hand back to Vince.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [8]
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Yes. Thanks, William.
So we’re on Slide 19, regulatory developments. I won’t spend too much time on these. Obviously, emissions trading scheme pricing is a reasonably positive thing from a Mercury point of view, and our carbon credit balance is positive. So we are well positioned in that space. I won’t dwell on transmission pricing. I think we’ve spent 10 years talking about that but simply to note that the decision made by the authority is being challenged by others, and we will continue to watch how that develops over the next 12 months or so. Importantly, the electricity pricing review actions are being worked through. And I just wanted to note here that a particular focus of the industry but of Mercury as well is on medically dependent and vulnerable customer guidelines. And I think, to maintain high levels of credibility for the industry and high levels of credibility for the brands in the industry and particularly for Mercury, navigating this with care and empathy is an important part of our social license to operate. So we will be focused on doing our very best on that, just note there that there has been a Waitangi tribunal resumption interim decision, which we continue to monitor and work through. And there is a note in the accounts saying that, that is unlikely to impair our ability to operate our hydro assets.
Turning to Slide 20 then. Looking forward, we are providing guidance. I think the reason that we are in a position to be able to provide that is due to the very strong work that we’ve done around our portfolio management and which is all about always thinking forward and how we position the business to give investors some certainty about our trajectory.
So FY ’21 guidance, based on 3,900 gigawatt hours of hydro, is $515 million EBITDAF, with dividend guided to $0.17 per share, up 7.6%; and stay-in-business CapEx guided at $80 million. We are very focused on deployment of cash in the business. And clearly we are continuing to think about efficiency and resilience when it comes to operating costs and stay-in-business CapEx.
So the chart there, that provides somewhat of a bridge and noting the fact, as William said a few moments ago, that July has continued the rather dry run that we’ve seen. And of course, that does impact the outcome, but I think you can take from this that the underlying structure of the business and its approach is being rewarded by being able to adapt to quite a wide range of scenarios. So both wetter and dryer periods, both higher and lower demand and also North-South Island price separation. We are well positioned to handle those things.
So I think, with that, operator, I’ll throw it open for questions.
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Questions and Answers
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Operator [1]
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(Operator Instructions) We have multiple questions in queue. Our first question is from Grant Swanepoel from Jarden.
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Grant Swanepoel, Jarden Limited, Research Division – Research Analyst [2]
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Great results for a tough year, hydro front. Can you please talk to the $11 million portfolio effect that’s coming through in your guidance, with particular reference to C&I? I’m interested to see if there a lot of liquidity in the 2- to 3-year contracts at these higher levels. And then also in terms of mass markets pricing, [if final quarter and then I sort of bumped it], should I assume that, that price increase sticks the whole year around? And then on your wind farm, are there any penalties associated? And are you still at the $465 million CapEx envelope for the whole project?
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Vincent John Hawksworth, Mercury NZ Limited – CEO [3]
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Okay, thanks, Grant. So I think there were 3 questions in that question. And I will defer to William in a moment, but I think the first thing you can take from the first 2 parts of your question is that from a portfolio perspective, by contracting out through the period ahead of us, we’re reasonably well set for FY ’21 and don’t have a lot of business to place for that period and hence our comfort with guidance. With respect to mass market pricing, yes, there has been a reflection of Mercury moving from the approach which was to have acquisition pricing and then bumping it up to much more of a pricing philosophy that is standard pricing. And we — yes, we do expect that to hold reasonably through the ensuing period notwithstanding the fact that we do expect competition to pick up. I think we will see more of that in the South Island, as compared with the North Island, at the least in the immediate future. With respect to Turitea, I might get William to speak to that because he’s probably got a bit more of the detail at his fingertips as he is carrying the burden at the moment.
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William Meek, Mercury NZ Limited – CFO [4]
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Thanks, Vince. So Grant, yes, on Turitea, as Vince says, it’s a fixed-price EPC contract. Obviously, that’s subject to agreed variations, but I mean it’s pretty standard in those contracts that time delays ultimately result in some form of cost to the contractor. And so that’s something we’re working through certainly in terms of our guidance to the market in terms of those project costs at $464 million. Those costs still — where we are right here, right now, still — are still okay. But time delays will obviously mean reduced revenue because the plant is not running. And certainly, contractually some of those shift back to — potentially shift back to the contractor.
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Operator [5]
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(Operator Instructions) Our next telephone question is from Andrew Harvey-Green from Forsyth Barr.
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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division – Director & Senior Analyst of New Zealand Equities [6]
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Vince and William, a couple of questions from me. First of all, just following on, on Turitea. I guess one of the interesting things that Contact has raised in their result call was when discount factor, they believe, will increase from $5 to $10 a megawatt hour to around about $40 to $50 after the smelter closes, I guess, due to some transmission strains in Central North Island but also the increased [hot sale price] volatility. Just interested, I guess, in your thoughts on that, what your analysis is saying around what that — when discount factor might be going forward.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [7]
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So thanks, Andrew. I’ll pass on to William, and I’m going to see. He may have a deeper insight than I have. I — but I would think about our Turitea project as providing gigawatt hours, but we still have choices in the portfolio to think about with respect to the way we operate Lake Taupo and the Waikato River chain. And in that sense, we can manage our portfolio. And its connection, I think, is — I don’t expect that connection to be overly constrained, with some expectation that there will be some backing out of thermal as well in the North Island. But William, what’s your thoughts?
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William Meek, Mercury NZ Limited – CFO [8]
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Yes. I suppose, I mean, I don’t have an exact answer, Andrew. The challenge obviously arises with much [mass riding] generation. And if you treat winds as mass riding , I mean, it’s going to be off-peak generation which is going to cause you the problem. Obviously, yes, the South Island hydros will face that in abundance. And so insofar you’ve got any ability to hold water, then you’ll do so because you can generate in a later period, whereas obviously a geothermal plant or one plant, if it reduces generation, you can’t make that back at a later point. So that’s the ultimate question is how do wholesale prices respond when you essentially got a [blast] of renewables hitting the market. So that’s where I really see it. Certainly, a 222-megawatt wind farm sitting inside our hydro portfolio which can run from 50 to 1,000 megawatts can certainly — would certainly buy a lot of flexibility to manage that variation within our generation fleet, but obviously that doesn’t apply when you’re already getting minimum generation on the Waikato.
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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division – Director & Senior Analyst of New Zealand Equities [9]
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Yes, yes, okay. Second question — no, just a couple of questions actually just around the dividend guidance for next year. First of all and in terms of coming up with that particular number, to what extent are you including Turitea earnings in that? Is it just the $5 million EBITDA that you’re showing in the guidance bridge? And secondly, I assume you are confident that — even in a worst-case scenario around the smelter and, I guess, a bit of a retail price war that you don’t foresee the need to cut that $0.17 a share going forward.
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William Meek, Mercury NZ Limited – CFO [10]
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Yes, so…
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Vincent John Hawksworth, Mercury NZ Limited – CEO [11]
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William, do you want to answer that?
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William Meek, Mercury NZ Limited – CFO [12]
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Yes. So no, it’s a good question. Obviously, I mean, the long — the future is uncertain, but certainly based on our financial analysis and looking forward, that guidance represents our 13th consecutive year of ordinary dividend increases. And we certainly — I think we’ve laid a strong foundation in FY ’20 for FY ’21. We do have some advantages against some of our peers. One, Turitea represents 2% market share, so that’s certainly a positive as it comes into the portfolio. Two, our dividend settings historically have been set lower, again, than market averages. So there’s certainly headroom there. And certainly, by the time we get out past FY ’25, we’re fairly confident that with — some fuel substitution but also decisions will be made across the generation fleet to bring the market back into a better supply-demand balance, which it clearly won’t be for certainly around through that year [that it closes], in ’22.
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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division – Director & Senior Analyst of New Zealand Equities [13]
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So (inaudible), I guess you will be looking to, I guess, look through any trough earnings through FY ’23 — or ’22 to ’24, I guess, with your dividend going forward.
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William Meek, Mercury NZ Limited – CFO [14]
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Yes. So again, I mean, as you look forward, obviously the company has got contracts in place. It’s got a portfolio of retail customers. And it’s hard to see. [I mean it] doesn’t just reprice instantly. And that’s you’ve got to — hopefully, you’re winning all those new customers. You do it one by one. And so therefore, there is definitely a lag in the system, [as far as] prices are suppressed, in terms of what the — how that flows through. But certainly, your C&I book does roll off through time. And it’s hard to escape the tide in terms of renewing those contracts.
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Andrew Rupert Pelham Harvey-Green, Forsyth Barr Group Ltd., Research Division – Director & Senior Analyst of New Zealand Equities [15]
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Yes, yes. And last, I guess, slightly detailed question from me just in terms of OpEx guidance for FY ’21. I mean, I think, in the past, you’ve held things pretty constant in nominal terms. We can assume that again $190 million for next year is a reasonable what you’re looking for.
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William Meek, Mercury NZ Limited – CFO [16]
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Yes, it’s a good starting position, but certainly with this focus inside the firm around resilience and productivity and business improvement — which again is not unique. Everyone is doing it in the face of COVID-19 response but — and Tiwai exit particularly, that certainly we’ll be continuing to look for opportunities here around doing things better.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [17]
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Yes. I mean just to add to that, Andrew, I — that the — obviously, we want to focus on making sure our revenue line is as robust as possible, but as William says, we’re not immune to the opportunity that comes with all this disruption to do things better and to do things better to lock in better performance in the future. So we certainly are having a really good look in the mirror, at the things we should stop, start and continue to do.
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Operator [18]
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Our next telephone question is from Stephen Hudson from Macquarie Securities.
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Stephen Hudson, Macquarie Research – Head of Research [19]
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Well, just 3 for me, if I may. Just on the stay-in-business guidance of $80 million, I just wondered if you could discuss whether or not that involves any deferral of the half-life work that you’ve got on the Waikato chain or whether or not we could see that sort of $80 million as sort of a new sustainable level. Secondly, just the fair value adjustment for Tilt, could I check with you that you said that $5 million to $6 million of the $18 million was included in the guidance. I just wanted to clarify that. And then thirdly, maybe one for Vince, just on NZAS: Some of the other generators have obviously, I think Meridian has, indicated that all 4 of the major generators pitched in with TPM underwrites and the most latest cuts of the contract. I just wondered if you can discuss or confirm whether or not you did actually sort of participate in that underwrite and what your logic was in doing so.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [20]
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Thanks, Stephen. I might touch on — so I’ll deal with the first one first, and then I’ll pass to William on the second one. And then we can come back to the third one, which is a little tricky, I have to say, but starting with the first one: In terms of that stay-in-business CapEx, yes, there is some deferral of the work on the Waikato River upgrade program not driven by — and not driven primarily by a cash preservation issue but more by our determination that, if we — when we make those investments, we want to make them with great certainty about the value that we’re creating. And part of creating value is ensuring that we can get the right people through the border at the right time with the right equipment and do the job in a highly professional manner. And I think it’s fair to say our confidence level about pushing forward with the next project too fast then was lower given the COVID issues and given the issues of getting people through the border. So we’ve taken what I think is a pragmatic approach and said these projects are not — they’re not “die in a ditch” type projects, but they’re projects that you should execute with confidence. And by giving ourselves some breathing space, that’s more likely to be the case. So yes, some of that money will flow forward into future years as we continue to make sure the Waikato River chain is New Zealand’s best catchment and New Zealand’s best peaking station. With respect to the accounting question, the second one, I’ll pass to William.
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William Meek, Mercury NZ Limited – CFO [21]
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Thanks, Vince. So just to confirm: So our guidance we set at $480 million assumed we were looking at about a $5 million Tilt share of profit. The actual Tilt result was closer to $16 million. So you’ve got a buffer of about $11 million. So if we take the $494 million and [put $11 million] out to normalize that, you’d be down at $483 million, which I think is — seems to line up with where [we and James are]. So just changes with the accounting [here in that] bargain purchase of $18 million and there a $2 million reduction for the core profits, giving $16 million for Tilt, yes.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [22]
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And just going back to your last question, Stephen, on NZAS. I — just I think it’s important to contextualize this. So when Rio announced the review, clearly there were different interests from different parties. And Mercury was approached about participating in various arrangements and which we looked at, subject to Commerce Act clearance. However, since the subsequent announcement that Rio has made that sets a date for their exit, we have had no further involvement. And I’ll think logically, given the clock is ticking, there’s probably 2 other players in the marketplace who are best positioned to come to a conclusion about whether there’s a better way than an August ’21 closedown. And I guess you’ve had a chance to talk to 1 of them just recently. And another one’s results will be out shortly, but clearly they’re the 2 participants best — I think, best positioned to have that conversation with Rio.
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Operator [23]
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(Operator Instructions) And we have a question from Nevill Gluyas from Jarden.
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Nevill Gluyas, Jarden Limited, Research Division – Director of Equity Research [24]
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Hopefully, you can hear me.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [25]
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Yes, we can hear you.
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William Meek, Mercury NZ Limited – CFO [26]
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Yes, Nevill.
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Nevill Gluyas, Jarden Limited, Research Division – Director of Equity Research [27]
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Great. Okay, just 2 questions from me. First question is just in relation to the post-Tiwai world and maybe just a bit further elaboration on some of those concerns that others have expressed about wind G watts. Do you have a view about the sort of separation, price separation, risk between the middle, low North Island and the upper North Island in respect of — obviously that relates to Turitea, but there’s a lot of other assets down there affected by that as well. Do you see that as becoming an active constraint in a post-Tiwai world?
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Vincent John Hawksworth, Mercury NZ Limited – CEO [28]
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Do you want to go first, William?
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William Meek, Mercury NZ Limited – CFO [29]
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Yes, you go Vince. [I’m looking for follow-up, yes].
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Vincent John Hawksworth, Mercury NZ Limited – CEO [30]
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Okay. I mean, look, I think in the post-Tiwai world the reality is that all of the surplus generation in the bottom of the South Island has to make its way out over time. And they will be generated — and for that to occur, there needs to be transmission upgrades. My biggest view on this is we have to be careful that we don’t end up creating a series of major investments to shift generation around which doesn’t actually benefit the economy as a whole. So I hope we’ll stay economically rational on those things. Once we get — when we get more generation coming across the HVDC in periods when there is surplus generation in the North Island, so I suppose it’s a very wet, very windy period, yes, there will be periods of constraint. But equally, I think there will be periods of very high price as well when effectively demand can’t be — there will still be constraints coming out of the South Island, I think, and there will be periods when demand is volatile and high in the North Island. So I, really from a Mercury perspective looking at our asset mix, go back to the portfolio issue for wind in Mercury’s business. And that is we can think about Turitea and Taupo as a bigger battery from our perspective. So we will operate the portfolio to maximize our ability to generate revenue.
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Nevill Gluyas, Jarden Limited, Research Division – Director of Equity Research [31]
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Great. I guess I hear that as being in part obviously about volatility, but in part, your answer is that you have a great big lever with the Waikato asset. So to the extent there’s price separation, you may not be incentivized for that price separation to continue if it’s affecting the wind farm revenue
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William Meek, Mercury NZ Limited – CFO [32]
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Well, I think the further comment I would make, Nevill is that, when you’re talking — the growth generally is — it’s generally operating in an unconstrained way at the moment. And that’s quite important because that means power flows freely from power stations in the South Island all the way to Auckland with a fairly predictable basis. When you move to the scenario with the Tiwai exit and a number of transmission constraints, that assumption is no longer true. So the management of basis and how you hedge a generation book against ultimately a customer sales book becomes much harder. And you talk about constraints where you’ve got only mostly hydro competing. What prices are we talking about? Are we talking about prices in 0, which is the worst-case scenario? I mean there’s every incentive, therefore, for generation to do something about that. I mean it’s hard to make money generating if you’re getting paid nothing for it. And also it makes it very difficult to hedge exposures in Auckland when you’re not getting paid for the power you’re making in South Island. So there you’ve just got to be really thoughtful around how do people manage their positions. And then you end up with actually limited supply for active customers and also with constraints because we’re sitting there and — how are we going to manage the basis for us — to these customers well, particularly in peak periods? So I think it’s unbelievably complicated. And I think there’s [simply you’ve got water that go under the bridge] before that’s reconciled.
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Nevill Gluyas, Jarden Limited, Research Division – Director of Equity Research [33]
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Yes, very good. And second question really is just in relation to the delays getting full power out of Dundonnell through Tilt and whether or not you’ve got any sort of updates over the last recent days and more thoughts about the process of persuading the owner to bring those onto the grid.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [34]
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Well, I think what I would sort of say to that, Nevill, is I think Tilt’s got its ASMs tomorrow. And I think they’ll no doubt delve to that in some detail and at that presentation. What I would say is that the Tilt team is as good as anyone, in fact, I’d say, better than anyone in dealing with these sorts of connection issues. So whilst I am sure they’re very frustrated, I’m also sure that it will get navigated and that Dundonnell project will be a fantastic projects, but I might defer to Deion’s expertise. And I do know he will talk to that tomorrow.
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Operator [35]
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There are no more further questions from the telephone lines. I’d like to hand the call back to the speakers for closing remarks. Please continue.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [36]
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Okay. Well, firstly, thanks, everyone, for getting on the call. I realize that we’re all trying to learn and adapt to life in various forms of lockdown. So I do appreciate you getting on the call. I hope we’ve given you some insight to the robustness of Mercury to these various unprecedented events that are occurring. And we look forward to continuing to work and communicate with you about our strategies to continue to be successful as Mercury. And I hope, by giving indication of where we see our guidance, that provides some confidence that we are on top of the issues. So thank you very much.
William, anything you want to add?
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William Meek, Mercury NZ Limited – CFO [37]
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No, that’s great. No, thanks, everyone, for spending the time with us this morning.
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Vincent John Hawksworth, Mercury NZ Limited – CEO [38]
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Cheers. Thanks very much, operator.
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Operator [39]
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Thank you. Ladies and gentlemen, that does conclude the call for today. Thank you for all participating. You may all disconnect. Have a great day.
