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 30th of June of 2022. [Operator Instructions] I must advise you that this conference call is being recorded today. I would now like to hand the conference over to Vector's Chair, Jonathan Mason, who will take you through the call. Please go ahead, Jonathan.

[Foreign Language] Good morning to you all. Welcome to this event. My name is Jonathan Mason, and I am Vector's Chair. Today, we are going through Vector's results briefing for the full year ended 30 June, 2022. Joining me on the call today are Group Chief Executive, Simon MacKenzie; and Chief Financial Officer, Jason Hollingworth. Today, we want to provide insights into what we see as the key aspects of the results and allow time as we noted earlier, for Q&A with you all. Detailed financial statements are available on our website. I will begin today's presentation with an overview of the Group's performance and the dividend for the full year, then hand over to Simon to talk about insights and highlights from FY '22. Jason will then give more detail on the overall financial performance before going back to Simon to take us through each business segment prior to closing with a short comment on Vector's outlook. We will then be happy to take your questions. So on a high level, Vector has delivered a steady result for the 2022 financial year against a backdrop of inflationary pressure, sustained supply chain challenges and constant evolution of the impacts from the COVID-19 pandemic. The Group recorded adjusted EBITDA of NZD 510 million. This was down NZD 3.5 million or 0.7% on last year's results and is in line with the guidance provided at the half year. Total capital expenditure for the year was NZD 245.9 million, an increase of NZD 4.4 million or 0.8% on the prior period. The increase reflected continued investment in infrastructure to support Auckland's continued growth, higher network replacement expenditure and continued rollout of advanced meters in Australia and New Zealand and the rollout of 4G modem upgrades across the New Zealand advanced meter base. Group net profit after tax was NZD 160.9 million, which was NZD 33.7 million lower than the prior year, primarily due to a NZD 40.2 million noncash goodwill impairment of Vector's LPG business. This goodwill impairment means to summarize we couldn't increase our prices to offset very rapid cost increases, including the impact of higher Saudi Aramco contract price of LPG, higher ETFs and a weaker New Zealand dollar, all contributing to a significantly higher cost of gas, along with the impact of the increase in discount rates, the interest rates went up as of 30 June, 2022. This was offset in our results by higher capital contributions, lower interest cost and a gain from the sale of Vector's 50% shareholding in Treescape. And Simon and Jason will give more detail on this later. Operating cash flow was 3.9% higher at NZD 518.8 million. This increase was largely due to the higher capital contributions received in the period. And finally, on our results on our key non-financial measure, SAIDI and SAIFI, which looks at network reliability, we did better than a regulatory limit for the second year in a row. This was a solid accomplishment despite a tough year for wind events. So, that's it for the high-level results. Now on to the dividends. The Board has determined that the final dividend is NZD 0.085 per share, taking the full year dividend to NZD 0.1675 per share. The dividend is partially imputed at 10.5% and will be paid to shareholders on 19th September. I will now hand you over to Simon to talk about insights and highlights from the year. Simon?

Thanks, Jonathan, and good morning, everyone. Just before I start, I'd like to recognize and thank all of our staff and field service providers for their continued dedication to serving our customers through the year, which, again, has seen some very challenging times due to COVID and other issues such as weather. So firstly, our electricity and gas networks, total net connections continue to grow, with electricity connections up 1.6% to 600,112 and gas connections up 1.3% to 117,995. The number of new electricity and gas connections in the year was 16,684 compared to 18,839 in the prior full year. The level of gross investment continues to be at high levels with capital expenditure for financial year '22 at NZD 331.9 million. Electricity volumes up 0.4% at 8,361 gigawatt hours, with lower business volume offset by higher residential volume. We complied with our regulatory targets for electricity and gas networks, including SAIFI and SAIDI for the electricity network. The Commerce Commission is reviewing the inputs methodology for the first time since 2016. These are the key regulatory rules that underpin the way energy networks are regulated. There are significant challenges to address in the regime, given that it was not designed for decarbonization nor the level of network investment and innovation now being asked of networks in the face of electrification to meet decarbonization targets. Indexation continues to introduce the perennial challenge of inflation forecasting and back-ended cash flows, which risk the ability to finance the infrastructure investment that will be needed. Vector is advocating the review needs to focus squarely on the implications of the government's decarbonization goals for the energy sector. This is because the review comes at a critical time to ensure these settings are fit for purpose and properly support the transition to a net zero economy all the while being completed ahead of the government's 2024 Energy Strategy and 2023 Gas Transition plan. We believe the review should be approached with a significantly higher level of engagement between the Commerce Commission and the industry, and we look forward to participating fully. The Commerce Commission has also set the next Default Price Quality Path or DPP, for the gas pipeline business for the 4 years commencing 1 October, 2022. The new DPP allows for a moderate acceleration of asset depreciation. Our view is that this is a step in the right direction and is aligned with clear and consistent direction from government about the role of gas in New Zealand by 2050. We've been working constructively with the industry Commerce Commission gas industry company and the government, both individually and as part of the gas infrastructure group to seek a transition plan that works with customers, government and infrastructure owners as well as recognizing the option for renewable gas. More broadly, policymakers should take into account long-term interest of consumers at the level of an overall household energy wallet rather than separately considering electricity or gas pricing. In many instances, electrification may lead to overall savings for households, the largest being the potential for EVs to reduce household spending on petrol costs, by more than the increased spending on electricity, including the network investment needed to meet new demand, which customers pay through electricity bills. We will actively participate in the government energy strategy and believe we will bring a unique perspective to this strategy given our global alliances with leading technology companies as well as proven long-term experience in trialing, analyzing and operating new technology and solutions in the energy sector. To metering, in financial year '22, we deployed and built 93,000 advanced meters in Australia and 18,000 in New Zealand with volumes impacted in both jurisdictions by COVID-19. Our advanced meter fleet now totals 1.98 million meters across New Zealand and Australia with nearly 490,000 meters installed in Australia. We invested CapEx of NZD 156.7 million or 3.9% lower than the prior year and our 4G modem replacement program is well underway in New Zealand with around 200,000 complete today. Earlier this year, we announced a strategic review of Vector's metering business, recognizing that smart metering has become a critical part of the transformation and digitalization of the energy sector around the world and we are seeing strong demand from investors for these businesses. We expect to announce the outcome of the strategic review by the end of this calendar year. For Gas Trading, earnings, as Jonathan mentioned have been impacted by a significantly higher cost of LPG input prices, including Saudi Aramco contract price, emissions trading scheme and a weaker New Zealand dollar. Along with the impact of the increase in discount rate as at 30 June, this led to a 40.2% noncash impairment of goodwill of the electricity business, the goodwill dating back to when the acquisition of NGC occurred back in 2006. In natural gas, we saw improved margins and performance despite volumes being lower. We saw a 7.4% decrease in 9 kg LPG bottle swaps to 629,651 in a year, and LPG volumes were down 1.6% to 44,330 tonnes with bulk volumes and cylinder volumes down slightly. And in local gas, we saw a 10.3% increase tolling to 1,112 -- sorry, 112,913 tonnes. Other highlights against our Symphony strategy include Vector Technology Solutions continues to explore opportunities for digital solutions created through our strategic alliance with Amazon Web Services and other global partners. We are already providing services to 5 EDBs across New Zealand. We continued our strategic collaboration with X, the moonshot factory, formerly Google X, which is developing technology and tools to enable the virtualization of the energy system and assist in managing the complexities that will arise both in real time and for longer-term planning. We've concluded a 2-year trial to find out how EV drivers impact electricity demand patterns and how we can manage that while keeping the cost of new infrastructure to a minimum. This trial shows the benefits of looking at how to enable the energy transition from a number of different points of view, including the customer experience, pricing, network management and optimization. This is feeding into the work we are doing with the wider sector, including the criticality of smart charging for customers and distribution networks. As such, we continue to call for critical decisions to be made surrounding EV charging infrastructure, needing to be able to be controlled as this has far reaching impacts on network investment and affordability. Recent developments in the United Kingdom and Australia support this requirement, and we're pleased to work with many others across associations and industry that share the same perspective. Moving on to other highlights through the year. We achieved a 16.5% reduction in our carbon footprint. We published our second TCFD report and developed a carbon abatement cost curve that's helping us identify and prioritize areas we can focus on to reach our science-based target of 53.5% reduction in Scope 1 and 2 emissions by 2030. This year, we have also worked alongside Umbrella Wellbeing to develop a new mental health and well-being strategy. We recognize the role that workplaces have to support their employees' well-being, which benefits the individuals, teams and organizations. Personalized well-being assessments were completed by 675 staff and the aggregated results have informed our strategy. We continue to undertake annual pay equity reviews across gender, ethnicity and age and take action as required. Our proactive engagement with government and regulators continues with focus on solutions for the challenges facing our industry to enable an affordable and equitable decarbonization. For example, by highlighting the approximate cost per household of switching from gas to electricity to underscore our advocacy for a managed transition. I'd like to now hand over to Jason Hollingworth, our CFO, to go through our financials in more detail.

Thanks, Simon. Vector's financial performance for the year reflects a steady result with adjusted EBITDA of NZD 510 million. This is down NZD 3.5 million or 0.7% on last year's result. Adjusted EBITDA for our regular networks was NZD 355.8 million, up NZD 5.1 million against the prior year. This was largely driven by higher electricity revenue due to the growth in connections and higher recovery of pass-through and recoverable costs. It was partly offset by lower gas distribution volumes and the prior year release of loss rental rebates. Gas Trading adjusted EBITDA was NZD 21.9 million, down NZD 5.5 million against the prior year total of NZD 27.4 million. The result was primarily due to the impact of the higher cost of LPG product, which is only being partially recovered from higher consumer prices. The higher cost is result of the higher cost of LPG, higher ETS and a weaker New Zealand dollar. These increasing costs reduced the profitability of the LPG business and along with the impact of the increase in discount rates, resulted in us recognizing a noncash impairment of NZD 40.2 million. The reduced profitability LPG business was partially offset by an improved performance from the natural gas business where margins have benefited from a tight gas market. Adjusted EBITDA for Victor's Metering segment grew by NZD 2.1 million, 1.2% to NZD 173.7 million as a result of continued growth in advanced meter deployments in New Zealand and Australia, offset by increased operating costs shifted from capital expenditure due to changes in accounting policy and additional one-off income received in the prior period. Group net profit after tax was NZD 160.9 million, which was NZD 33.7 million lower than the prior year due to the NZD 40.2 million noncash goodwill impairment of the LPG business. This was offset by higher capital contributions, lower interest costs and a gain on the sale of Vector's 50% shareholding in Treescape. The bulk of this goodwill arose from the acquisition of NGC Holdings in 2006 and reflected the value of the legacy gas contracts owned by NGC that were allocated to Vector Gas's CGU. Vector made attractive returns from trading this legacy gas, but under accounting rules, this goodwill could not be amortized against these earnings. Gross CapEx was up 0.8% to NZD 545.9 million. This increase reflects ongoing investment in infrastructure to support Auckland's continued growth, higher network replacement expenditure, continued rollout of advanced meters in Australia and New Zealand and the 4G media modem replacement program in New Zealand. Note this increase in capital expenditure was partly funded by a NZD 29.3 million increase in capital contributions that was recognized as income under IFRS. Net CapEx after deducting these capital contributions was down 5.9% to NZD 394.1 million, with growth CapEx down 4.6% to NZD 319.6 million and replacement CapEx up 9.5% to NZD 226.3 million. The increase in replacement CapEx was driven by the 4G modem replacement and Arc meter replacement programs in New Zealand. During the year, our debt increased by NZD 158.8 million to NZD 3.229 billion. Our gearing, as measured by net debt to net debt plus adjusted equity was 58.2%, and we remain investment-grade credit risk with a Baa1 rating from Moody's and a BBB rating from Standard & Poor's. During the year, we successfully completed NZD 857 million of refinancing, consisting of NZD 325 million of 3-year bank facilities, a NZD 225 million 6-year senior bond and the rollover for a further 5 years of NZD 307 million of our perpetual capital bonds. I'll now hand back to Simon to look at the segment performance in more detail.

Thanks, Jason. I'll now talk through the segments in a little bit more detail, starting with Regulated Networks. Jason has already covered earnings for these segments, so I'll focus on some other details. We continue to control costs despite a very high inflation environment. The current high inflationary levels aren't reflected in financial year '22 revenue. The regulatory mechanism allows for an inflationary adjustment, but this won't flow through until regulatory year '24. That's an estimated NZD 16 million impact. Total net connections continue to grow with electricity connections now topping 600,000, up 1.6% to 600,112, and gas connections were also up, as previously mentioned. Gross regulated CapEx increased by 4.7% to NZD 331.9 million compared to NZD 316 million the previous year. Our CapEx, net of capital contributions was 7.3% lower than the prior year at NZD 181.6 million. CapEx continues to be at historically high levels due to the investment to improve reliability, resilience of our network as well as higher growth, reflecting the continued growth in Auckland and infrastructure projects across Auckland. For the regulatory year, 31 March, SAIDI, our measure of network reliability was 92.4 minutes below the regulatory -- sorry, 92.4 minutes within the regulatory limits, which are just over 100 minutes. Bulk and cylinder sales were lower compared to the prior year. Total LPG sales were down 1.6% at 44,330 tonnes. Bottle Swap 9 kg volumes were down 7.4% to 629,651 bottles from 680,099 a year earlier. This decline is partly attributable to the impact of COVID as well as the major -- as a loss of a major customer from December '21. LPG tolling volumes were 10.3% to 112,913 tonnes from 102,351 tonnes a year earlier, and natural gas sales volumes were down 3.3 petajoules to 5.3 petajoules from 8.6 petajoules. Advanced meter base grew 6.5% to 198 -- sorry, 1.98 million from 1.86 million. And as we said previously, we've deployed nearly 490,000 advanced meters in Australia. Total metering CapEx invested was 3.9% lower at NZD 156.7 million due to the lower level of advanced meter deployment in the period, partially offset by increased expenditure for our 2G modem replacement program. So now look ahead, Vector is well positioned to enable decarbonization guided by our vison, which is to create a new energy future. Despite the challenges of climate change today, our Symphony strategy helps us seize the opportunities of a decarbonized future by creating a decentralized energy system that opens future possibilities, delivering decarbonization consistent with safe, reliable and affordable energy solutions for all customers. Our wider industry has never seen the level of change that is before us or the critical nature of getting the transition right. Collaboration across the industry, government and regulators is vital as is learning from our overseas counterparts, and we'll continue to anticipate fully and advocate for our customers. We expect growth in electricity and gas connections to continue. The high level of CapEx is set to continue, driven by high connection growth in Auckland, advanced meter deployments in Australia and New Zealand, rollout of 4G modems and advanced gas meters in New Zealand. The impact of higher inflation on regulated revenue is deferred by 2 years, as mentioned earlier, under the current regulatory model. We have a strategic review of the metering business underway and we, as mentioned, expect to announce an outcome by the end of this calendar year. We intend to provide guidance at our financial year '23 interim results. And I'll now hand back to Jonathan.

Thank you, Simon. In closing, I'd like to thank everyone at Vector and our field service providers for their continued effort as we take further steps toward our vision of a new energy future. Simon, Jason and I are now happy to take any questions.

[Operator Instructions] Our first question will come from the line of Andrew Harvey-Green from Forsyth Barr.

Jonathan, Simon and Jason, a couple of questions from me. First of all, just around the metering business and a couple of questions on the strategic review and the process there. I think it's been widely expected that you're, I guess, looking at the partial sale and 50% is the most likely outcome. Is that [indiscernible] sort of situation where you might sell more or less?

Simon?

Andrew, yes, as we've announced and undertaken a strategic review, we see there's still great opportunity for us as a business, particularly with the Australian growth. We have obviously a significant market share across New Zealand and Australia and to look at their growth offshore. We do see a partnership and a 50-50 partnership is something that we see would be attractive.

And secondly, I guess the other question that's -- is on most people's lips really is around use of proceeds from any sale, assuming it does take place. Is it largely going to be used to repay debt and fund future growth? Or is there any potential for a capital return?

You have it right, Andrew. It's -- we'd be looking use of proceeds, both to repay debt but also position us for attractive growth opportunities. And we're very high on over the next 2 years what the growth in the Australian metering market would look like with a great partner. So, that would be use of proceeds. But first, the strategic review has to be completed. So, it's probably too early to talk about use of proceeds.

And final question on metering is just in terms of this year's results. I'm looking at the revenue number in particular. So, I think the number of meters installed increased 6% and net revenue even after adjusting for the one-off last year, only increased 4%, which sort of implies pricing went backwards. My understanding was that there is, I guess, some sort of CPI-linked growth in most of the metering contract. So can you just, I guess, talk to that a little bit more?

So, starting with your last question, yes, there is CPI linkage to the contracts in Australia. So, that's positive. There's a waterfall in our slide presentation that shows you the EBITDA impact does call out the growth in Australia. There were some adjustments in the prior year that I think has distorted the view of that, which we try to call out in the waterfall. So in doing your numbers, I'm not sure whether you've adjusted for that correctly, but I guess that's something I'd be happy to take offline with you afterwards. But yes, there is -- I mean, it's a competitive market in Australia. There are pricing pressures, but we are continuing to perform well there and expand our meter base.

And the last question was just around the LPG impairments. And it sounds like most of it was, I guess, around the margin squeeze and you're kind of seeing that as structural, which I just wanted to unpack a little bit more because the things that you signaled, I would have thought it should be able to be passed through to consumers in time. So, can you just talk to why you sort of see that margin reduction as being structural impermanent as opposed to just a temporary thing?

We do see it as more temporary, Andrew. So, we think we will return to historic profitability in that business over the next couple of years. Half of that impairment was purely due to the increase in discount rates we've seen over the last -- actually, those in the last 6 months when we last tested. So, more than half of it is purely discount rate movement.

Which sort of makes the next couple of years more important, years 5 to 10...

That impacts it...

Sort of the discount rate...

Recovery a couple of years.

Discount rate, mathematics.

[Operator Instructions] Our next question will come from the line of Phil Campbell from UBS.

Just a couple of questions from me. Jason, is that -- with the impairment on the LPG businesses, do you have like a book value for LPG? Or was it part of a larger CGU?

No, it is disclosed separately. Its book value is around NZD 75 million. So, it was previously NZD 40 million higher than that.

The other one was just I looked at one of the [indiscernible] accounts, it talks about the lost rental rebates. It looked like there was a component in the result of NZD 8.7 million. Could you just run us through whether that's true? And what -- so is that effectively a boost to FY '22 earnings? And obviously, you'll then pay that back to consumers later on I imagine?