Vector Limited (VCT) Earnings Call Transcript & Summary

Good morning, everybody. Welcome to Vector Limited's conference call and webcast to discuss the company's financial and operational results for the half year ended 31 December 2019. [Operator Instructions] I must advise you that this conference call is being recorded. I'd now like to hand you over to Vector's Chair, Dame Alison Paterson, who will take you through the call. Please go ahead, Alison.

Good morning, everyone. Again, welcome to Vector's results briefing for the half year ended 31st of December. As you know, I'm Alison Paterson. I am Vector's Chair. Joining me on the call today is Group Chief Executive, Simon MacKenzie; and Chief Financial Officer, Jason Hollingworth. A reminder that as in recent briefings, we are not intending to go through a detailed page-by-page recital of the investor material. Rather, we want to provide insights into what we see as the key aspects of the results and allow more time for Q&A with you all. I know many of you have a keen interest in dividend, so I will begin today's presentation with a summary of Vector's half year dividend payment and changes to Vector's dividend policy. I will then hand over to Simon to provide an overview of the key aspects of the half year results. Jason will comment a little more on the numbers before Simon will close with a short statement on Vector's outlook. We will then be happy to take your questions. So as to dividends. When the Vector Board approved the current dividend policy in 2017, we agreed that we would review the policy once again once we knew the outcome of the DPP3 regulatory reset. The reset is crucial for Vector because it determines the maximum allowable revenue for our electricity business as well as limits for network quality standards. We received final confirmation of our regulatory resets in November last year. The DPP3 period will take effect from the 1st of April 2020 and run through to 31st of March 2025. Considering the Commerce Commission's final decision, the Board has decided to update the dividend policy. The Board has resolved to move from a policy of progressively increasing dividends by $0.0025 per annum to a policy of maintaining the current dividend of $0.165 per annum. Please note, we expect to increase dividends in the future based on projection -- projected growth in Vector's businesses. And the dividend policy statement, which we'd upped onto the network this morning, states that, "We believe this approach is more in line with other listed companies." The Board has also decided to move away from a policy of fully imputing dividends to attaching imputation credits at a rate of 10.5%. Therefore, shareholders will receive a partially imputed dividend payment of $0.0825 per share on the 8th of April 2020. I'd like to add that in considering the payment of any dividend under this updated policy, the Board will ensure that the company will maintain its current BBB credit rating with Standard & Poor's or the equivalent; secondly, have the financial capacity to meet its medium-term investment and operating requirements; and finally, comply with all funding covenants and the solvency test in the Companies Act. I will now hand you over to Simon to provide more insights into the year.

Thanks, Alison. I'd like to start by touching on some of the key -- of the operational highlights for the half year. Auckland's growing population has once again contributed to strong electricity and gas connection growth. We made 8,488 new electricity and gas connections, up 24.3% on the prior comparative period. To keep pace with Auckland's growth and enhanced network integrity, we invested $156 million in our networks during the period. This works out to $6 million invested every week, which is a 25% higher than the same period last year. This effort helped us to achieve a 13.7% improvement in SAIDI minutes as well. Overall, electricity volumes were flat at 4,396 gigawatt hours, with higher residential volumes offset by lower business volumes. Metering growth continued in both New Zealand and Australia during the half year period, with 61,000 additional meters deployed in Australia and 23,000 in New Zealand. We now have 1.64 million advanced meters in our fleet, with 222,000 of these in Australia. During the period, we invested $65 million in capital expenditure to continue growing our Metering business. This was an 8.9% increase compared with the equivalent prior period, with most of the increase reflecting the acceleration of deployment of new advanced meters in Australia. The growth and innovation opportunities for metering in both New Zealand and Australia continue to be significant. And with continued investment, Vector Metering is on track to deliver another solid performance in FY '20. In early December, a key milestone for our Gas Trading business was reached with plans confirmed to transfer the Kapuni gas treatment plant and associated assets to Todd Energy. The deal resets the relationship between Todd and Vector and creates strong alignment in terms of our shared interest in seeing the Kapuni field developed further. The sale, which is due to be completed in the coming months, will not have a material impact on adjusted EBITDA for the Gas Trading business in FY '20. Our Gas Trading business' financial performance delivered a good result given the very challenging market conditions. This included a 1.7% lift in LPG bottle swaps. And now I will hand over to Jason to provide an overview of Vector's financial performance.

Thanks, Simon. For anyone that's got the slides, I'm on Slide 4, which is an overview of Vector's financial performance. Our revenues continue to benefit from strong connection growth across our networks and the further expansion of the Metering business in New Zealand and Australia. However, these gains were partially offset by increased maintenance to improve electricity network reliability aligned to the DPP2 period. The group delivered a steady earnings performance for the 2020 half year with adjusted EBITDA of 265 -- $264.5 million, which was in line with last year's comparative result. We've invested capital expenditure to improve asset reliability, support growth in Auckland as well as investment to support increasing deployment of advanced meters. Reflecting these priorities, total capital expenditure in the first 6 months has been $240 million, an increase of $38.9 million or 19.3% up on the prior period. Group net profit after tax was $80.5 million, down $2.8 million on the prior year's result. This result was largely driven by higher depreciation, amortization and increased maintenance costs, partly offset by higher capital contributions and lower interest costs. Operating cash flow was $256 million, up 16% on the prior year's results. The stronger cash flow was driven by several factors, including lower interest costs, higher capital contribution receipts, lower loss rental rebate payments in the period compared to the prior year and working capital movements. On to Slide 5, looking at the segment earnings. You'll note that we've made some changes to the segment structure, with Metering now separated out into its own segment. The remainder of what was traditionally been known as our Technology segment is now included as Other. Adjusted EBITDA for electricity and gas distribution in the 6 months to 31 December 2019 was down $9.5 million to $189.2 million, a 4.8% decrease compared with the prior period. This result was largely driven by lower sales revenue and the phasing of electricity maintenance expenditure focused on improving network reliability and reducing outage minutes. Gas Trading business' financial performance in the 6 months to 31 December saw adjusted EBITDA flat at $20.8 million. As Simon mentioned earlier, we see this as a good result given challenging market conditions. Adjusted EBITDA for the Metering segment was $76.1 million in the 6 months, up $8 million or 11.7% from a year earlier, with most of this increase reflecting the acceleration of deployment of new advanced meters in Australia. Vector PowerSmart's HRV business has continued to focus on improved business operations over the 6-month period, and this is -- and HRV's financial performance has improved. This is expected to continue into the second half. And Vector Fibre has also improved its performance over the period. Looking at Slide 6. During the period, we invested significant capital expenditure to improve asset reliability, support growth in Auckland and increase deployment of advanced meters in Australia and New Zealand. Reflecting these priorities, total capital expenditure in the 6 months has been $240 million, an increase of $38.9 million or 19.3% on the prior period. Capital contributions rose $3.9 million or 9.5% to $45.1 million from $41.2 million a year earlier, reflecting continued connection growth and the significant development taking place across Auckland. And I hand back to Simon to talk about the DPP3 reset.

Thanks, Jason. So on to the outcome of the DPP3 regulatory reset. As Alison has already mentioned, Vector received a final decision from the Commerce Commission in late November last year. The weighted average cost of capital has been set at 4.57%, which is down from 7.19% is the previous default price period to expected return. This will see a revenue reduction of circa $25 million relative to the year to 31 March 2020. The expected impact in quarter 4 this year is $7 million. The impact on revenue would have been greater had Vector been earning its full allowable revenue in regulatory year '20. However, the Commerce Commission forecast inaccuracies have resulted in Vector earning an actual return of 6% as opposed to the allowable 7.19%. As we have previously outlined during the 2013 to 2019 regulatory years, Vector's under-recovery of actual revenue relative to allowable revenue was approximately $270 million. While we acknowledge that the DPP3 regulatory settings have partially been corrected to remove growth forecast inaccuracies, it is disappointing that exposure to ongoing inflation forecast errors, inaccuracies remain and in what we believe to be an inappropriate risk-free rate input into the weighted average cost of capital when compared to other jurisdictions. Furthermore, the reset has created $189 million funding gap for the DPP3 period. This restricts the capital expenditure available to Vector over the next 5 years and comes at a time when we're experiencing significant growth of Auckland's electricity network. Although this outcome will impede our ability to invest in Auckland to the level we believe is necessary over the next 5 years, we are committed to upgrading and maintaining Auckland's electricity network to the best of our ability. Accordingly, we have adjusted some of our policies to reflect the funding envelope we have been allowed by the Commerce Commission. Lastly, we expect these line charge reductions to be passed through to customers given this regulatory reset. Turning to outlook. We expect Auckland growth to continue, and we are still targeting around 12,000 new electricity connections in FY '20. In Metering, we are targeting 50,000 to 60,000 additional advanced meters in New Zealand and 130,000 to 140,000 in Australia. In terms of guidance, adjusted EBITDA guidance is between 100 -- sorry, $495 million and $505 million for FY '20 and CapEx guidance of circa $500 million. Alison, Jason and I are now happy to take any questions.

[Operator Instructions] Your first question today comes from the line of Andrew Harvey-Green from Forsyth Barr.

A couple of questions for me. And first one, just around the dividend and clarifying a couple of things. In terms of, I guess, imputation levels going forward, it looks like that you're no longer intending to prepay tax, which is, I guess, what you've done in the past. Once that prepaid tax balance has gone, in essence, will you be looking to increase imputation levels to whatever tax levels you are paying? And how soon do you expect that to actually take place?

Look, I think that's a reasonable assumption, Andrew. Yes. But the Board obviously will consider that down the track. I think the policy is all about the Board having opportunity each reporting period to consider its dividend policy, having regard for the performance of the business.

Okay. So there's nothing formal, I guess, around imputation policy as such.

Yes, no, nothing formal.

The Board accepts that it's inefficient to prepay tax to impute dividends. And we intend to cease doing that.

Yes. Okay. That's great. Second question is actually just a clarification. When I was sort of calculating the numbers according to the distribution, I guess you're talking about imputation tax credits, I think, of just under $0.01, $0.00967. I was calculating this as an imputation level of 30.2% as opposed to 10.5%. And if it was at 10.5%, it would be around about 0.33 of a percent. You may just want to double-check that and come back in terms of what the expected imputation level is. Just wanted to clarify that.

Yes. I think I know what you're talking about, Andrew. We spent a bit of time on this yesterday, just looking at how the NZX likes this to be disclosed. So the tax credit is 10.5%. There are some issues around how different people disclose that in terms of percentages of imputation, so happy to take that off-line with you.

Yes, sure. Okay. And last question for me is whether you have given any further consideration of going to a customized price path, and I guess you've had 3 months to digest the full price path decision.

Andrew, it's Simon. Look, I guess the reality is that we consider the customized price path. We're having conversations with the Commerce Commission. But as you appreciate, we also have to focus on the challenge in front of us with regards to growth in Auckland, but that is something that we are considering and in dialogue with the Commission.

Your next question comes from the line of Grant Swanepoel from Craigs.

Just first question on the Auckland demand and how that's going. I see demand for ICP is down 1.4%. I think the trend was starting to stabilize. Is this a new trend developing? Or is it just a weather-dependent situation?

Yes. Grant, I think as we've identified, there's a difference between business and residential. So we're seeing residential will be slightly higher and business will be slightly lower. But overall, I think we've seen a -- over the years, we've seen a gradual decrease in demand or volume. We've seen that slightly flatten. But again, I think you're correct with regards to the impact of weather and temperature. It probably explains some of that variance we're currently seeing at the moment.

And then in terms of natural gas, down another 9% in volume terms. Do we have to wait for your new Kapuni deal to come through before we see a stabilization in those volumes?

I think with regards to the Kapuni deal being down 9%, it's largely to do with -- from a volume perspective of ceasing to supply a large commercial customer. And as I guess what we'll see with the Kapuni deal, then that gives us certainty about volume for liquids and some of the gas, and we'll continue to operate. Obviously, appreciate it's a very challenging market conditions at the moment, but the volume was largely to do with the reduction given the loss of a large commercial customer. Jason might add one thing.

Yes, just -- we're having a couple of field outages and including in the current period as well. So it is a tough market with these outages and given our trading sort of book. So yes, I think we've said it's challenging and it is. So Kapuni will help, but we still buy gas from some of these other fields, and they have been out over the period.

And my final question, just on that other HRV side of things. So don't get me wrong, I'm really pleased that you're splitting out meters. But those little businesses are now going to be lost in corporate. If those do rebound back beyond this $4 million to $5 million per half, will you be disclosing what's going on there relative to corporate costs going forward?

Yes. We will, Grant. There's accounting rules about when you can treat something as a segment. So until we get to that level, we just have to treat them in that Other bucket. So we can have bucket of Other, we just -- we have to do what we've done. So if it gets to a size, we will break them out again. But I think that will take a few years before you get to that point.

Your next question comes from the line of Stephen Hudson from Macquarie.