Mercury NZ Limited (MCY) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Mercury Limited interim results briefing. [Operator Instructions] And just please be advised that today's conference is being recorded. But I will now hand the conference over to your first speaker today, Chief Executive, Vince Hawksworth. Thank you, and please go ahead.

Good morning, everybody, and welcome to this presentation. I'm joined by William Meek, our Chief Financial Officer. I'll move through to Slide 3, which outlines the highlights of the first half of the FY '21 year. We've had a positive first half. That's largely been driven by a strong trading performance and by a lift in yields across all of our sectors. And at the same time, overcoming some headwinds due to continued low hydrology, which we continue to face into the future. Wholesale prices have remained elevated. And obviously, the New Zealand Aluminum Smelter decision has firmed those prices alongside the gas constraints and the hydrology that we have seen. But the positive thing about all of this, of course, is that we do have a clear pathway to the transition to a low-carbon economy. And this pricing sends strong signals for new investment. Our customer segment yields have improved. However, competition has remained fierce, and we expect that to continue through the coming period. We've been very focused on operational improvement programs. Those programs, which we've called our thrive initiative, are focused on process, performance and culture. And we've signaled that we are looking for an improvement in EBITDAF of circa $30 million in the FY '22 year from that program. Our investments into Turitea continues to face some headwinds and difficulties. But we do now see that the North section of the project will likely be completed in October of '21. That's largely about overcoming the access arrangements with the -- for the blades, but we do see a pathway to completion. The Southern section, we still remain challenged by the physical nature of the terrain and the civil engineering issues are providing some challenges. We're confirming our interim dividend of $0.068 per share, which is a 6.3% increase on the same period last year. And full year guidance of $0.17 is also confirmed. This will be the 13th year of ordinary dividend growth. If we turn to the next slide, we can see the breakdown of that financial performance. So energy margin, reflecting the yield story that I mentioned before. Our operating expenditure, reflecting less planned outages compared with the period -- previous period and the focus on operational excellence. That giving us the uplift in EBITDAF. At NPAT level, the gain on Hudson Ranch sale, our U.S. geothermal investment has provided us with an uplift. Free cash flow has improved and remains positive. And prudent management and post-COVID issues have meant that our stay-in-business capital expenditure is lower than the previous period. Our growth investment reflects Turitea capital investment. I'm now going to pass to William, who will take us through the next slide.

Good morning, again, to those on the call. So we're now on Slide 5 with the earnings bridge for half year 2020, starting at $258 million, and particularly bridging to this year's result at $294 million EBITDAF, so an increase of $36 million, a good bridge where most of these steps go up rather than down. So certainly, the period saw a slightly lower generation, lower hydro, but higher geothermal performance so about 108 gigawatt hour downward swing against the PCP. We saw higher prices in this period versus the prior half year. And so that benefits generation and obviously is the detachment of the retail portfolio, which is shown in the chart. We did see an easing back in volumes. And a benefit there in terms of prices as yields across all segments lift us strongly. So 7% on mass market, so $138 a megawatt hour. And in the C&I segment, up almost 9% to $94.60 a megawatt hour. Vince has called out the trading performance. And you can certainly see that strongly with a $14 million delta in derivatives there. And those are bridged more exhaustively on Slide 20 of this deck. OpEx, it was down $6 million and other up, again, on the back of recognition of our share of profits and Tilt Renewables and from the sale of our interest in the HR1 plant in California, leaving us with our half year EBITDAF of $294 million. I'll hand back to Vince for Slide 6.

Thanks, William. So just looking at these key performance indicators. On the customer line, our brand remains strongly positioned and we continue to be pleased about the way that, that performs in the marketplace, especially in the construct of the second line, where the Climate Change Commission draft report is supportive of electrification and the government's commitment to vehicle emission standards really is very strongly aligned with the Mercury brand and the Mercury brand story. Turning to kaitiakitanga. We continue to look at our emissions intensity, and we will continue to try and drive that down as part of doing our job for net carbon neutral future. Turning to people. I guess it was disappointing for us to have an increase in TRIFR, total recorded incident frequency rate. But that has got some explanation around it, given the high levels of activity on the Turitea site. We've worked closely with both Vestas and Downer on process controls around injury risk and hazards on that site. And I'm pleased to say that we are seeing a significant improvement in the way that site's being operated. From a commercial line perspective, as we've said, we announced the dividend of $0.068 per share as the interim dividend and continue to stay on track for our progressive dividend increases. Stay-in-business CapEx is lower, and that reflects both the effects of COVID and our focus on maintaining our positive cash flows. So I'll hand back to William for the next few slides.

Thanks, Vince. So we're on Slide 7 now, a very familiar scatter plot here, graphing delta to national storage averages, so those New Zealand Lake levels versus the Auckland spot price. Certainly, again, the first half of this financial year, again, seeing elevated prices. So again, a lot of dots and yellow scattered with those black and blue really coinciding with elevated prices since the Pohokura outage in 2018. So certainly, issues with the gas market and tightness of supply definitely feeding through to spot prices throughout the country. TCC has -- essentially has gas just for winter hasn't run for some months. So during the summer months has been offline. We're seeing high commitment now with the Huntly Rankine. A lot of that, I suspect, on coal. So gas definitely feeding through to high prices. Hydrology nationally has been challenging over the last 4 months. So New Zealand is running a 6% inflow, it's largely driven by the South Island, which traditionally would be in its wettest inflow period over those summer months, so very acutely dry in the South Island. And then obviously, carbon outlook on the back of the Climate Change Commission report released end of January, certainly outlook there for carbon prices to continue to rise as the government looks to it's net 0 carbon targets in 2050. So the second chart here on Slide 7 really showing the decline in thermal generation. It singles out the Huntly Rankine units, which certainly, in recent years, have been running at much lower levels than they were at the beginning of last decade. And then you see a very huge step-up there in the Otahuhu futures price with the calendar year 2021. Now pricing at around an average of $180 a megawatt hour, and then falling back slightly to $140 and then $120 by cal '24. So phenomenal step change in energy costs relative to the relatively modest prices for most of the last decade. It is sort of sitting in the $80 a megawatt hour range. Turning to Slide 8. A slightly different representation of similar data. Again, a number of price curves here, the yellow line showing the spot price, and we can see that big step-up in terms of rolling price from late 2018. The blue line showing Otahuhu futures price, which has steadily risen from '18, and then get very, very strongly from February this year and against, essentially, Mercury's adjusted mass market energy yield. So certainly, again, spot prices and against futures prices, those yields on a cost adjusted basis well underwater relative to underlying energy costs of benchmark to futures and current spot. So certainly, that price, as Vince has already mentioned, the commitment for the smelter to remain in operation through to December '24, certainly shoring up demand. Demand generally pretty resilient in the face of COVID-19 impacts with only very slight reductions. So again, New Zealand performing fairly well there in regard to demand. And certainly, we are seeing and expect to see further generation development announcements to essentially look to bring supply on to, one, decarbonize New Zealand's electricity sector, but two, to certainly introduce supply to bring those power prices back from these elevated levels. Turning to our customer business on Slide 9. Again, a very familiar chart in terms of net gains and losses. We do continue to focus on customer value, looking to optimize that value across all our sales channels. So that's into spot markets, the commercial/industrial and mass markets, that's residential and SME. The strategy has seen a lift in sales yields across all those segments, which I've already referred to. Powerswitch comparisons are very interesting. When we look at those across networks throughout New Zealand, we certainly can see quite a disparity in pricing between Mercury's offers and the cheapest offers from other major gentailers. So those deltas are quite large, ranging between $20 to $60 a megawatt hour. So a very large gap with a note calling out that based on segment reporting, retail operating costs running at about $25 a megawatt hour. So certainly, again, on the chart on the prior page, we're seeing some quite large negative gross retail margins against that. When we look at our strategy, our losses have been largely flat once normalized for the decision to exit the Farm Source contract. And -- but what you can see very distinctly there is that Mercury's acquisitions have been steadily declining over that 2018 to essentially early '21 period. In terms of fixed price sales, fixed price sales commitments across C&I and mass markets have actually lifted. So the company is actually selling more fixed prices to end-user customers with a reduction in mass market sales volumes of 117 gigs with C&I increasing by 172 gigawatt hours. On to Slide 10, which looks at lake management. So clearly, management of Lake Taupo, which feeds the Waikato River catchment and hydro chain. Very, very important. So we can see in the yellow line, a good performance and actually dry conditions to bring the lake up to near its particularly normal -- well, what would I call it? Operating you can upper bound at 357.25 meters above sea level. So we're getting pretty high, almost 600 gigs. And then you've seen a sharp decline essentially the drought particularly. But again, from January, February with us slightly below mean levels at this time, certainly, in a fairly strong position going into the autumn months, where we expect to see Taupo Lake levels continue to decline. But again, inflows running for the year-to-date at around the lower quartile. So again, dry in the North Island, which has been a thematic over the last couple of years. But more acutely seeing very dry conditions starting to emerge in the South Island. I'll hand back to Vince.

Yes. Thanks, William. So looking at Slide 11 here. I mean, I think you're all aware that the Climate Change Commission draft advice has come out. And it can only be seen as positive for the sector with renewable energy being the key driver for decarbonization. I guess from Mercury's perspective, we support the view that it's the adoption of renewable energy rather than 100% renewable electricity. However, in reality, the direction is net positive for the sector anyway. And I think it's -- we need to be careful about focusing purely on any individual target, but more the market conditions and the environment for continued investment. So that's strong support for transport electrification and for process heat decarbonization is really important. Also note that there was a UTS with subsequent actions to correct. And Mercury is unlikely to be materially impacted in that process. So turning to Turitea. So as I said, not without challenges, however, looking at it from a positive perspective, the transmission and grid connection works are largely complete and are available for energization as soon as we have an operating wind turbine on the Northern section, where we have 14 base towers and 10 nacelles installed and the photograph there shows the Black Hawk helicopter delivering the top of a transmission tower and a crane lifting a nacelle. Of course, blade access has and remains a critical element. We have increasing confidence that, that problem will be overcome. And on that basis, expect completion of the North section in October '21. Obviously, the shape of that and pace to that time will be dependent on blade delivery. The southern section does provide a much more significant challenge with contracted delays and knock-on impacts from the late completion of the northern section. Now whilst the later schedule shows a significantly later commissioning and a large delay. We continue to work with our EPC contract, Vestas, to try and find ways to bring that date forward. As I noted on the earlier slide, health and safety has been a major focus on what has proven to be a pretty challenging site from a civil construction perspective. But we are pleased with the latest audit we've done and with the positive way that Vestas and their subcontractor, Downer, have sought to ensure that hazards are well managed. Turning to the next slide. Now like all businesses, I think COVID-19 caused us to take stock and think about how resilient and efficient we are as a business. And it has been fantastic to be able to use an in-house review team of the brightest and smartest within Mercury to look at opportunities for us to work smarter, faster and better. But also importantly, set a culture of improvement that will stand us in good stead for many years to come. None of that happens without, obviously, setting some targets. So we've come to a view that there is a $30 million EBITDAF benefit to be achieved. And importantly, in achieving that, that we will be able to focus on new ways of working, using data better across the business, more digitization looking at where -- what customers value, improving our capability. And we've proven that already to ourselves through an Xcelerate program, which was looking for opportunities that emerge from the business and taking those through to fruition in a more deliberate, purposeful and faster way than we perhaps would have in the past. So that's all about being fit for the future, but also being resilient to change. So looking at Slide 14. Our issue of the green bonds, we were really pleased about. Because it proved once again that our business reflects what investors care about: a sustainable, better world. Our sale of Hudson Ranch was a great outcome after many, many years of hard work by a very small team to, I guess, get out of some quite complicated arrangements. We have retained a small interest in a technology looking to extract lithium from geothermal brine. We're obviously always looking at M&A opportunities. And clearly, there are 2 well canvassed strategic reviews going on at the moment. I will be making absolutely no comment on the Tilt process. But I do confirm that Mercury is participating in the Trustpower strategic review of its retail business. We're now turning ourselves to think about what happens after Turitea and the great asset that we have in the Puketoi wind farm. We firmly believe that, that is not only mercury is next best generation development opportunity, but amongst the best new generation opportunities in New Zealand. So we'll be looking to progress that and understand both the economics and the pathway to a decision on build. Simplification is a bit of a theme that we've got going through our business at the moment. And we note there are 2 things that we have done to reduce complexity, getting out of Mercury Solar through the sale to ChargeSmart and the consolidation of the Bosco brand. So to wrap up, we did review guidance again, and we have revised that to $520 million. That really reflects the significantly dry conditions that we have seen through late January and into February. Also reflects the fact that wholesale prices in the ASX remains significantly elevated for the remainder of the year. Of course, as we always say, the change in the weather may result in a change in the guidance. We do confirm, though, that our year for FY 2021, dividend guidance is maintained at $0.17 per share. And that stay-in-business capital guidance has been revised down from $80 million to $70 million. So with that, thanks for your attention. I think we can head back for questions, operator.

[Operator Instructions] Your first question today comes from Grant from Jarden.

First question on the EPC contract delay. I think at the start of the year, we're looking for about a $5 million EBITDA from Turitea in this fiscal year. Is there further damages we'd be expecting to be incorporated in your guidance for FY '21?

No. There's no LDs in the '21 guidance.

Is that how the contract works in terms of what you're expecting to earn? You'd recoup that from the provider?

Yes. So the way liquidated damages would be treated for accounting purposes, they need to be -- they're like an insurance contract payout, so they need to be effectively certain. So essentially, why you're in a -- until you get through that process and essentially either strike an arrangement and clarify those, they're going to be paid, then you won't recognize them. So...

The $30 million of continuous improvement benefits, it sounds very much like a cost-out program. Can you give some sort of split between revenue opportunities and cost out in that $30 million?

Look, Grant, it's Vince here. I think at this stage, we're probably not ready to give you that guidance. There's still quite a few projects that are in early stages, but it is across revenue and cost. And yes, part of it is improving, doing business with ourselves, like all organizations over time, you can look at opportunities that simplify things. And you could take a bit of a stair from the executive structure changes that I've made as an example of where that opportunity is. The move to consolidating generation, for instance, provides opportunities to reduce friction in the business. But look, we'll talk about that some more at the full year.

And then as you saw 4 months left in this fiscal year, are we expected to see any of that benefit this year? Or is it all accruing into FY '22?

Any benefits that we see this year is still built into our guidance as it stands today.

My final question, just on your commentary that you are looking at the Trustpower retail opportunity. Could we also consider you guys looking at maybe buying the New Zealand assets out of the Tilt process? Or is it too early to tell there as well?

You obviously didn't listen to the no comment bit, Grant.

Your next question comes from Andrew Harvey-Green from Forsyth Barr.

A couple of follow-up questions from what Grant was asking, first of all, just on the $30 million benefit for FY '22. I just wanted to confirm that, that is all, I guess, incremental on top of any sort of yield increases and obviously sort of Turitea benefits that will come through?

Yes.

Yes.

Okay. And secondly, are there any costs likely to actually deliver those benefits?

Well, there's obviously going to be investments in multiple places to improve processes and systems and things of that nature. But we've made an EBITDAF target for a reason, and that's because that's the level of uplift we want to see.

Okay. So the uplift is net of any costs to deliver in essence?

It's at the EBITDAF level. Yes.

Yes. Yes. Okay. Second question, just in terms of the Turitea delays, I'm just confirming that there are no financial implications for yourselves rather than, I guess, the delayed earnings, which will get offset in due course by any LDs.

Yes. So it's best to talk about Turitea in the 2 parts. The North, as Vince says, where we expect that to complete in October. The South is definitely more challenged. You're looking at an almost 2-year delay. So we need to work through that with the contract of Vestas.

Okay. So it is possible that it may end up having some higher CapEx associated with that then?

Too early to tell. It's just time. It's mostly driven by time. But time obviously does have BI consequences.

Yes, yes. And the second sort of Turitea question is just to understand that some of the blades were on the Napier ship that caught fire earlier. You didn't mention any sort of implications from that.

It wasn't blades, it was nacelles.

Nacelles. Right. Yes.

But no, that won't cause any delays. They will get remanufactured and delivered before they're needed.

They're not critical path, Andrew.

Okay. Yes. Next question was just in terms of the drop in OpEx and the drop in the maintenance. Is that just more of a timing thing? Or is that sort of an ongoing step change? Or is it reasonably a chunky step change in the first half?

Largely a timing issue from a perspective of one half year to the next and influenced by the fact that these things do occur partly and partly influenced by, obviously, reframing what we do under the sort of COVID world that we were living in. However, it's fair to say that as we've worked through all of those things, that's some of the opportunity that we've also seen in the way we approach OpEx that will lead into that $30 million.

Yes. Yes. Okay. Last question for me is just, I guess, around Puketoi, but a more broader question in terms of looking at -- we've seen a number of new developments announced. I suspect there might be 1 or 2 more coming in the next couple of days. What is your thoughts, I guess, around the balance in the market once all of those things go through and concerns around overbuild or potentially even underbuild and how then Puketoi fits into that?

Well, I suppose a starting position from my perspective is that in any market situation, the most valuable projects should get built first. Now obviously, there's a competitive overlay to that, so people will make decisions based on what they can influence. The next thing -- when I think about Puketoi is its location and wind resource is exceptional. So it is a project that will get built. Timing, obviously, we still need to work through the risks of. I suppose at the moment, the risks of overbuild are, whilst they're real, the environment we're in at the moment is it's, I think, really important that the sector steps up and shows a pathway that will take us past this very challenging transition we have over the coming years with uncertainty around gas and with the fact that we do need to see coal burn reduce if we are going to meet our targets for decarbonization. So that's -- it's something that has to be navigated, that we have to be aware of all the time. However, I think it's far worse if the sector sits on its hands and doesn't start to deliver real sustainable change.

Our next question comes from Cameron Parker from Craigs Investment Partners.

Well done on a good first half and shame about Turitea, but I'm sure that will come along. Look, can you give me a feel for Turitea generation coming on in terms of gigawatt hours over the financial years over the next FY '22, '23?

Yes. So '22 based on the timing for Turitea, October full commissioning will be -- so you can just take essentially a pro rata of the 470 gigs for an annualized output. And then given the date of July or mid-'23, you'll end up with the South coming on for a full year from '24, FY '24.

Okay. Just looking at your residential customer numbers and volumes that are coming off. What sort of level of concern do you have there? And also, are you going to be putting through any residential price increases over the next 12 months or so?