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 full year ended June 30, 2020. [Operator Instructions] I must advise you that this conference call is being recorded today. 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, and welcome to Vector's results briefing for the full year ended 30th of June 2020. My name is Alison Paterson, and I am Vector's Chair. Joining me on the call today is our 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'll begin today's presentation with a summary of the dividend for the full year and then hand over to Simon to provide an overview of key aspects of results. Jason will comment a little more on the numbers, before Simon takes us through the performance of each business segment prior to closing with a short statement on Vector's outlook. We will then be happy to take your questions. So on to dividends. As signaled earlier this year, the Board decided to move from a progressive dividend policy to a policy of maintaining the current dividend of $0.165 per annum, with the expectation of further dividend growth based on projected growth in Vector's businesses. This means that the final dividend of $0.0825 per share, taking the full year dividend to $0.165 per share. The dividend has partially imputed at 10.5% and will be paid to shareholders on 21st of September 2020. I will now hand you over to Simon to provide more insights into the year.

Thank you, Dame Alison, and welcome, everyone. For those of you online, we are now on Slide 4. So this year, the COVID-19 pandemic has presented us all with challenges, unlike any we've seen before. And as a provider of essential services, our role and contribution to our communities has been accentuated more than ever during this time. Our organization started preparing for COVID-19 in January, and we are proud of the commitment our teams and key partners have made to serve our customers through extremely challenging times. Our integrated group strategy, which we have called Symphony, positions us well for the challenges of today and the opportunities we will seek out in the future. We are tracking well towards our objective of providing sustainable returns through a diverse portfolio, and further, defining our company as an innovative energy group with a growing local and international impact. We continually focus on capital allocation between different assets to deliver best results possible, and given regulatory settings, we have adjusted our policies in regard to capital contributions recently. Firstly, our electricity and gas networks. In November 2019, our Default Price Path 3, otherwise known as DPP3, regulatory settings were confirmed through to 2025. These came into effect on 1 April, providing targets for electricity network quality and allowable revenues for the next 5-year period, which commenced, as I said on 1 April. We'll come back to this later. New electricity connections increased to 12,231, up from 11,000 in the prior year, while new gas connections were down 3.6% to 3,201. To keep pace with Auckland's growth and enhanced network integrity and reliability, this year, Vector invested at an all-time high of $317 million in our electricity and gas networks, which was 21.5% more than last year. And overall, electricity volumes were 1.1% lower at 8,315 gigawatt hours, with lower business volume partially offset by higher residential volume largely attributable to the COVID-19 lockdowns. In our Metering, this business continued to grow well in New Zealand and Australia, with 119,000 advanced meters deployed in Australia and 36,000 in New Zealand. This brings our total advanced meter fleet to 1.71 million, with almost 280,000 of these in Australia. To support this growth, we invested CapEx of $133 million which is 10% more than last year. In our Gas Trading business, we were pleased to complete the sale of the Kapuni Gas Treatment Plant and association assets to Todd Energy in March 2020. We had a 6.6% increase in 9 kg LPG bottle swaps, bringing the total to 701,923, a spike of activity was seen at the start of lockdown. Liquigas had a 5% increase, totaling 116,024 tonnes, and gas liquid sales were down slightly by 2.2% to 43,338 tonnes. Our Energy Solutions business, Vector PowerSmart, has delivered several major projects in New Zealand and the Pacific and is well positioned as a leading provider of advanced energy solutions in the region. Our Vector Fiber business has continued to perform well this year and is progressing plans to create new products and services to capitalize on changes in the telecommunications landscape. Jason will talk in detail later about E-Co Products Group, HRV. We're showing positive performance streams. However, the consumer-facing and seasonal nature of this business means that we were unable to trade during lockdown, which spanned the peak trading time for this part of the business. Turning to now Slide 5. In terms of other business and operational achievements, we were pleased to recently announce our strategic alliance with Amazon Web Services, or AWS. This multiyear partnership is evidence of our Symphony strategy in action and will see us co-develop a cloud-based new energy platform to radically improve the way we collect and process energy consumption data from our advanced meter fleets both here and in Australia to help unlock innovative energy products and services to benefit customers. The strategic alliance to jointly develop the new energy platform is the first of its kind for AWS in New Zealand and for AWS and the global energy sector. The AWS team saw in Vector a strong cultural alignment between our 2 companies, and we are excited to work alongside them and our energy industry partners to bring this to life. Building a diverse and inclusive culture is an important part of our overall approach to sustainability. In August 2019, we were awarded the Empowerment, the Diversability and the overall Supreme Award at the Diversity Works Awards for our commitment to building an inclusive and supportive work culture. This is the second time we have won the Supreme Award, the first being in 2019. Continuing with sustainability, we saw a 12.6% reduction in corporate carbon intensity. This includes business travel and building fleet fuel, gas. We were targeting an annual reduction of 5% in carbon. We successfully raised over $1.1 billion of debt in the financial year, utilizing both the domestic and the U.S. markets. In one of the largest deals for a New Zealand-based entity in recent times, we secured $500 million from the U.S. private placement market for 12 to 15 years, which has allowed us to further extend the maturity profile of the group debt portfolio and preserve liquidity. I'd now like to hand over to Jason, our CFO, to go through the numbers.

Thank you, Simon. I'm on Slide 6 of the investor pack. In the past year, Vector delivered a steady financial performance, recording adjusted EBITDA of $490 million, which was up $4.2 million or 0.9% on last year's result. Overall, while we benefited from continued advanced meter deployment in New Zealand and Australia, this was offset by the regulatory Default Price Path 3 reset from 1 April and the impact of COVID-19. Lockdowns resulted in lower electricity network volumes, and therefore, revenues, driven by a significant drop in commercial sector consumption as well as an impact on other parts of the group. Across the Vector group, we estimate adjusted EBITDA earnings were adversely impacted by approximately $10 million as a result of COVID-19. Capital expenditure was $488.7 million, $63.6 million or 15% higher than last year. This increase reflected ongoing investment in infrastructure to support Auckland's continued growth, higher network replacement expenditure and increasing deployment of advanced meters as market demand continues to accelerate in Australia. Group net profit after tax was $97.3 million. It includes a noncash impairment of $32 million in respect of the E-Co Products Group. As Simon mentioned, despite improved performance from HRV in the first half of financial year, level 3 and 4 restrictions, a subsequent impact on the wider economy and the uncertainty around long-term consumer confidence has impacted HRV's gross trajectory, resulting in us taking a conservative approach and impairing recurring value of the E-Co Products Group as we're seeing here again the impact of the current lockdown on this business. Operating cash flow was 14.1% higher at $397.3 million. This increase was largely due to a number of factors, including lower interest paid, higher receipt associated with loss rental rebates and higher capital contributions. Now on Slide 7. As mentioned earlier, comparable segment earnings were up $4.2 million to $490 million. I'll now break down by segment, starting with the Regulated Networks. Earnings for our Regulated Networks were $337.6 million, down $29.4 million or 8% against the prior year. The lower result was driven by the DPP3 price reset on 1 April, which saw prices reduced by 6.9%. With higher maintenance activity linked to the improvement in reliability and resilience of the network as well as the impact of COVID-19, we saw lower volumes across our electricity and gas networks after level 4 lockdown began on the 25th of March. Gas Trading earnings was $33.9 million, up $2.3 million against the prior year total of $31.3 million. The sale of the gas -- the Kapuni Gas Treatment Plant resulted in a decline in earnings in Q4, which was largely offset by positive cash flows reported below the line as part of interest cost and this will continue in the future. The overall impact to earnings was not material to the FY '20 result. Adjusted EBITDA to Vector's Metering segment grew by $16.1 million or 11.6% to $154.8 million as a result of continued growth in advanced meter deployments in both New Zealand and Australia. I'll now hand back to Simon to go through the segments in a bit more detail and to look a little further ahead. Thanks.

Thanks, Jason. I'm now on Slide 8. As Jason said, network earnings have been impacted by the DPP3 reset. The impact of the inflation assumptions selected by the Commerce Commission is a significant issue we are facing. Those assumptions used in setting our new price path have for a decade systematically over-forecast inflation and, in turn, reduced our revenues below levels consistent with a fair return. This is an impact that will be further exacerbated through to 2025, given radically different inflation expectations since the DPP reset was determined in late 2019. Nor do we believe this is a sustainable outcome or one that is consistent with the legislation intended to ensure regulated businesses can invest for the long-term interest of consumers and earn an appropriate return. This, however, is not an issue that is exclusive to Vector as other regulated entities in New Zealand face the same challenges, and we also note that a review is underway in Australia with the regulator on the same topic. We will actively engage with the Commerce Commission to seek a constructive solution. We consider this to be a critical matter that must be worked through collaboratively to ensure Auckland growth and government and infrastructure investments are supported through aligned regulatory settings, whilst ensuring fee returns to our shareholders. In the meantime, we remain committed to upgrading, extending and maintaining Auckland's electricity network to the best of our ability for the benefit of the energy consumers. With regards to Slide 9, in financial year '20, we invested $317.1 million of capital expenditure to improve the reliability, safety and resilience of our gas and electricity networks and facilitate Auckland growth. This is a 21.5% lift on the previous year's investment and reflects our ongoing commitment to reduce the frequency and duration of outages across our electricity network through a mix of new initiatives and innovative approaches to asset management. In FY '20, we significantly reduced SAIDI minutes and able to build on these achievements in FY '21. Our team had an extensive and ongoing focus on programs to drive reliability and network performance. Critical to this will be the continued adoption of new technologies and more advanced operating practices to drive better outcomes for our customers as well as targeted investment and a continued focus from our teams and field service partners. However, challenges remain in Auckland, such as climate change, volatile weather patterns, increased traffic and more cars hitting poles. We also continue to work with Auckland Council and the Ministry for Business Innovation Employment on vegetation issues affecting the network. Turning to Slide 10. With regard to the Gas Trading business, in December 2019, Vector announced the sale of the Kapuni Gas Treatment Plant and associated assets to Todd Energy. This transaction was completed on 31 March 2020. The deal aligns our shared interests in seeing the Kapuni field develop further. Natural gas volumes were down due to field outages and constraints on the supply side. However, the team managed these challenges well, which lead to improved margins over the period. Total natural gas supply in the period was 12.4 PJs, down 23% on last year, largely due to the loss of a major customer partway through the year. The LPG side of the Gas Trading business continues to strengthen, solidifying its reputation as a versatile and convenient energy choice for homes and businesses across New Zealand. Bottle swap 9 kg cylinder volumes were up 6.6% to 701,923 swaps and sales from 658,159 a year earlier. Liquid gas tolling volumes were up 5% to 116,024 tonnes, mainly due to the signing of a new enterprise customer in the second half of the year. Commercial cylinder and bulk LPG supplies were down, driven by a decline in demand during COVID-19, levels 4 and 3. Gas liquid sales were down 2.2% to 43,338 tonnes. Slide 11, metering. In the 12 months to 30 June 2020, we installed 36,350 advanced meters in New Zealand and 119,033 (sic) [ 119,003 ] in Australia. The advanced meter fleet across the 2 countries grew 10% to 1.71 million from 1.56 million the year before. We have now deployed almost 280,000 advanced meters in Australia, having met the 250,000 milestone in April during the COVID-19 pandemic lockdown. In Australia, we are now averaging approximately 10,000 installations per month. In October, Vector Metering announced a partnership with Genesis Energy to roll out advanced gas meters. Making Genesis the first energy retailer in New Zealand to offer its customers a digital gas metering solution. This innovation will provide Genesis customers with the benefit of full visibility across their gas use at home, giving them more freedom to make decisions about their gas usage long before their bill arrives. It will also avoid the need to have a meter reader because of the consumers' property. This could benefit the 110,000 Genesis gas customers. In the past year, we announced a significant upgrade program to replace all existing 2G modems with future-proof technology, which will support both 4G and 5G technology if it becomes available and widespread. Once complete, this investment will clear the way for continued meter connectivity and enable ongoing product innovation opportunities decades into the future for our Metering business. In March, we announced a partnership with Spark, who is a key connectivity partner for Vector as we look to modernize the way energy consumption is measured in Kiwi homes and businesses. The deal will see a significant number of Vector's New Zealand-based advanced meters connected to Spark's 4G-supported Cat M1 Internet of Things network, with the ability to shift on to 5G connectivity as part of a multiyear rollout. Now to the outlook, Slide 12. Before we look forward, I'd like to pause on the achievements of the last year. We are pleased with our performance with a large part of business operating as essential services during the lockdowns. During the first lockdown, we finalized the sale of Kapuni; a huge amount of work went into the strategic alliance with the AWS, Amazon Web Services during this time; meter deployment in Australia continued; and of course, the delivery of essential services from our electricity, gas, metering and fiber teams. I'd especially like to acknowledge the frustrations of planned outages on our electricity network during lockdowns to our customers, and we recognize the frustration this has caused, but we continually assess the need for any planned work and prioritize the work that is critical for continued supply or safety, balancing that against consumer impact. Unplanned outages caused by cars hitting poles, we had 6 in 1 day recently and storm-related events are, of course, prioritized and repaired as quickly and as safely as possible. So I'd like to thank all our essential workers, including our key field service partners who are out there in all weather throughout lockdowns, looking after our customers. For the coming financial year, we are targeting adjusted EBITDA of between $480 million and $500 million. This range reflects the uncertainty created by COVID-19 and subsequent -- sorry, and consequent economic conditions as well as the full year of DPP3 reset. We expect Auckland growth in advanced meter deployments to continue to grow at current levels. In the meantime, we remain concerned about the regulatory settings and the impact on our ability to invest. We must balance these external pressures on Vector with our responsibility to deliver essential services at affordable prices for consumers. In closing, I would like to take this opportunity to thank Vector people, suppliers and key partners. They have demonstrated resilience and adaptability in a constantly evolving and challenging year. So thank you all for your efforts and continued support as we strive towards our vision of a new energy future. And this is also a significant results announcement for us, as it will be Dame Alison's last with us before she retires at the Annual Meeting. Dame Alison's governance experience is unparalleled in New Zealand, and our heartfelt thanks goes to Alison for everything she has done for Vector. Dame Alison, Jason and I are now happy to take any questions. Thank you.

[Operator Instructions] Your first question today comes from the line of Grant Swanepoel from Jarden.

A few questions. The first one on the revenue cap. Was there a shortfall in the final quarter that you haven't caught up through the Transpower rebate system? Second question on Gas Trading. What is the outlook? Can you hold up the 12.4 PJs? And will the margins hold up now that we're getting a bit of a relief on gas supply in the market? Third question. What is the gas metering business? Will there be -- are those economics similar to the electricity metering business? Will there be some start-up costs? This 110,000 Genesis conversion, is that over 3 to 4 years? And then my final question. What is the contribution that Vector technology has to the regulated lines costs?

Grant, thanks for that. Jason, it's probably best if you just talk to the revenue shortfall number. So we're talking there, Grant, for the period for the first 3 months. But that has to be weighed up against the rest of the regulatory year because the regulatory year starts from 1 April, obviously goes to 31 March. So until such time as we've finalized that full year, we'll get a clearer picture on where it sits. But for example, in April, during lockdown alone, the shortfall was circa $5 million. And then there's been a bit of a recovery since then. So I think we're currently sitting around about net position around $5 million down. So those lost rental rebates are returned to us, they're allocated to us. They're not a specifically a rebate from Transpower's own revenues or anything. They basically pay to us as transmission payers of the service out of market excesses. With regards to Gas Trading, being able to hold the 12.4 PJs. We remain reasonably confident that we can remain competitive in the market. As we note with the Kapuni deal that we have excess to get through there. And our team have recontracted a number of customers out in the market. There remains a number of customers that are coming up for recontracting. But so far, we've been successful in contracting the large proportion of those and winning some back that we haven't previously had under contract. With regards to the gas metering, the -- your question about the economics of that, they are largely similar to the electricity meter deployments. The start-up costs is one of the first projects that we'll be doing under the AWS relationship as the platform that will host a lot of the gas metering technology. So there are some start-up costs associated with those. But the platform that we are developing with Amazon Web Services is what we would call a multi-fuel platform as opposed to building a customized bespoke platform just for a gas metering solution. So this platform will span both electricity and gas solutions and potentially any other top of infrastructure. And with regards to time frame, look, that's at least 2 to 3 years, but it will be dependent on just the rollout cadence with regards to interfacing with customers and meeting Genesis' needs. Lastly, with regards to Vector technology, the solutions that Vector technology provides to the electricity business include solutions such as the management of all the data circuits and also the SCADA control solutions and the platforms that operate our core electricity networks. But Jason, I might just ask if you wanted to add to -- anything to that as well.

Yes, look, I don't think it has a material impact on the regulated cost structure, but it does give that in -- the opportunity to look at any additional revenue from other third parties, particularly in areas like cyber, where we now have a service capability that we are looking at offering -- we are offering to other EDBs around the country. And there are similar services along those sort of lines where we are able to offer to other EDBs.

Jason, can I just follow-up on that? In your slide presentation, it's got a $6.7 million negative hit from other, which is put down to those services. It just seems a bit more radical than just your assistance to the business.

Yes. Perhaps, let me come back to you on that, I think.

Sure. And then on the gas metering business, when does that rollout start? I assume it's not in your metering assumptions for your guidance for this year?

You're talking about the gas metering in New Zealand?

Yes. So your guidance says a similar run rate on meter business for FY '21 relative to FY '20. I was just wondering whether there was any gas meter rollout included in that assumption.

There will be some gas meter rollout commencing in New Zealand, so that would be picked up in part of the New Zealand numbers, the solar ramp-up.

Yes. Solar ramp-up, Grant. Yes.

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

Just a couple of quick ones for me. I just wondered if you can give us some feel for your cost of debt coming into next year or this year, FY ‘21. You obviously termed out a fair chunk of it, but I just wondered if there's any more relief in the offering? Secondly, could you give us a steer on your underlying metering EBITDA growth, so sort of stripping out the installment growth? I think you've talked in the past about kind of 4% underlying growth. I just wondered if that was still a realistic number. Thirdly, just on the 4G CapEx rollout, can you give us -- could you scale that up in terms of dollars and time frame? And then just lastly, on the inflation forecasting error issue. I just wondered if there might be some innovative solutions that you might be looking at to hedge that risk through your debt book.

So just if I start with the first one, Simon, if that's all right, the interest costs. Again, we rolled -- we have a debt book that we manage. So as that debt continues to roll off, there will be an interest benefit coming through to us over time. So again, we run a traditional sort of book where we have a -- some of our debt hedged. So I think our average cost is around 4.5% at the moment. So that will continue to come down as swaps get used, and we're able to move to new rates reflecting current market rates. So there will be a continued benefit from that coming through over the current year. Second question. What was the second question, Stephen? Just so -- Simon's got it.

Yes. The -- yes. No, so the underlying EBITDA question for metering. But Jason, you might want to talk to that. We don't typically go into those detail.

Yes. But the growth should continue to be maintained. The net business has got a momentum at the moment that's continuing on. So I'd see that continuing in Australia.

In the -- and I'll talk to the 4G rollout. So that's a replacement of all modems across our metering fleet across New Zealand. That's currently planned to be a circa 5-year program at roughly about $30 million a year. And with regards to the inflation forecasting error, the issue there is that the Commerce Commission utilized the reserve bank midpoint target. So it's not technically an inflation forecast, it's a target, which typically sits around 2%. That is multiplied by our regulated asset base, and that's deducted from the revenue earnings for each of the DPP3 years. So for argument sake, if it's 2% times $3 billion, then that's $60 million deduction. But what the issue that arises is that we have to index at the actual inflation. So if the actual inflation sits at 0.5% as opposed to the 2%, then obviously, we're down 1.5% times regulated asset base and revenues that we should have collected, which is circa $45 million or for every 1%, it's $30 million. So with regards to looking at hedging resets, not a hedging issue as such. It's actually an issue about indexing of our asset base using inflation forecast here as there's a completely separate issue about the cost of debt, but the issue we're talking about here, as we say, is the same for other regulated entities and the same in Australia and the inflation forecasts in the, for example, the weighted average cost to keep debt -- sorry, weighted average cost of capital have no link to this indexing forecast.

Yes, I understand the issue, Simon, and that was useful. I guess the idea would be to try and find debt investors who are worried about inflation and who are wanting to buy inflation index bonds that would offset some of the risk. But anyhow, I can take that offline.

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

A couple of questions from me. First of all, just sort of understanding the sort of the sale of Kapuni impact. Am I right in effectively assuming that the cash you'll be receiving from that over time should roughly equate to, I guess, the EBITDA less tax impact that you will see through the EBITDA line? And sort of related to that, I think you looked around about that under $10 million is the impact that you sort of disclosed in simplistic terms from EBITDA impact for FY '21 should be, therefore, looking at sort of $7 million to $8 million EBITDA impact on the Gas Trading business?

That's right, Andrew. That's exactly right.

That's right, Andrew. And the other aspect that we should obviously note there is, from our perspective, it was very positive because of aligning the incentives between Todd and ourselves. And so as we look forward, if there's more reserves out of the field, then we see upside benefit from that through our Gas Trading business in particular.

Yes. Okay. And one final question on that in terms of the cash that you'll be receiving over the time, where in the cash flow statement is that going to sort of appear?

Well, we'd get a little bit of interest income, that will come through that line and the operating cash flow, but the bulk of that will come through our investing cash flows as we receive the secularly deferred consideration. So we had to value that consideration stream, which is what's on our balance sheet now, and that will be received in cash over the remaining life of the field. And we're required to sort of revalue that every reporting period in terms of the outlook for the field and the income that we're entitled to off that.

Yes. Okay. Second question is just around the new alliance with AWS. And should we be thinking about any sort of revenue or earnings coming from that alliance, I guess, sometime over the next -- if you think about a 5-year time horizon?

Yes. Andrew, the AWS alliance, first and foremost, for us, is about building the new energy platform that we require for our business, both here in Australia. And certainly, the objective is for both ourselves and AWS to then look to deploy that solution to other metering providers and energy companies globally. So we do expect that we would be looking to receive revenues from that. But at this point in time, we haven't set any specific numbers. The first best task is to replace all our existing platforms with regards to that multi-fuel platform, new energy platform we talked about. But certainly, we see a very wide market out there for these solutions that are being required as a result of regulatory changes and also consumer changes globally.

Okay. And last question is just around looking forward in terms of connection growth in the Auckland region, are you seeing much impact on that from COVID? And I guess, related to that is I think you alluded to a change in the capital contribution policy. So I assume you're looking for greater capital contributions coming from developers upfront. And therefore, I guess, what should we be thinking about from a capital contribution perspective for FY '21?

Okay. So with regards to what we've seen, when we came out of lockdown, there were certainly what we would call an increase in connection activity. We largely think that, that was as a result of people wanting to either bring forward the developments. We have just seen in recent months a drop away slightly, and we're not seeing for the first time, we're not seeing as much connection activity come through into our electricity team. With regards to the capital contributions, yes, we did increase our requirements for capital contributions from developers. That's as much as anything to do with the way in which the regulatory envelope is currently working for us. And so we will expect to see that potentially stay flat or reduce just depending on activity. Breaking that down at circa $96 million: $88 million for electricity; $7 million for gas; and about $1 million for fiber.

There are no further questions at this time. I would like to hand the conference back to today's presenters. Please continue.

So I'd just like to thank everyone for joining us. If there are any queries, analysts, please contact Jason, and he'll be happy to discuss those with you. And with regards to media, please contact Rachel Reynolds. Again, thank you all for joining us. We'd like to again reiterate our special thanks to all our essential service providers and our field service partners out there in all conditions. And lastly, just reiterate our sincere thanks to Dame Alison Paterson for all she's brought to Vector over the years. Thank you.

Thank you, Simon.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.