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 2023. [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, Doug McKay, who will take you through the call. Please go ahead, Doug.

[Foreign Language] Hello, everyone, and welcome to this presentation. I'm Doug McKay, Vector's Chair. Today, we're going through Vector's results briefing for the half year ended 31 December 2023. Joining me on the call is Group Chief Executive, Simon MacKenzie; and Chief Financial Officer, Jason Hollingworth. We'll start the presentation with comments from Simon on overall group performance, then Jason will go into more detail. Simon will then talk about the current and future market outlook, then I will come back to talk about the dividend. After that, we'll be happy to take your questions. I'll now hand over to Simon to start the presentation.

Thanks, Doug, and hello, everyone. Our goal has been to present these results in a way that makes it easy for year-on-year comparison, specifically noting the significant transaction at the end of the last financial year involving Bluecurrent, which was formerly Vector Metering. For the 6 months to 31 December 2023, Vector has delivered a solid half year result with adjusted EBITDA of $185 million, growing by 7% over the same period in 2023. As a reminder, adjusted EBITDA excludes customer contributions which is how we fund the majority of the customer-initiated growth costs on the network. Underlying net profit after tax was up 29% on the prior period. However, the group reported net profit after tax was $22 million from continuing operations as it includes a $60 million impairment of our gas distribution business. This impairment was driven by the Commerce Commission's regulatory decision to lower future returns to owners of gas distribution networks and interest rate changes. We note that Clarus, another transmission and gas distribution network operator, is appealing the Commerce Commission's decision on the gas WACC. Total capital expenditure was $238 million, an increase of 6% on the prior period. This continues the trend of year-on-year increases in capital expenditure. I'll now hand over to Jason to go over the detail behind these high-level numbers.

Thank you, Simon. I'm on Slide 7. This slide shows the segmental contributions towards a top line adjusted EBITDA figure. Adjusted EBITDA from Regulated Networks was up $4 million; Gas Trading, up $6 million; and Corporate and Other, up $1 million on the prior period. Group net profit after tax from continuing operations was $22 million. Simon has already spoken about the impairment, but another significant impact is net interest costs, which is $43 million down on the prior period due to the sale of measuring and the resulting impact on Vector's debt. The negative $19 million Other bar is due to our share of Bluecurrent's losses for the period and also the year-on-year tax difference, with tax being higher by $11 million this year, noting that the impairment is not subject to tax. Slide 9, which is a recap of the metering transaction. We thought it would be useful here to briefly recap how the metering transaction was structured and how we now report as a 50% owner. Last year, at 30 June 2023, we completed the sale of a 50% interest in Vector Metering to QIC. Vector Metering is now known as Bluecurrent. The sale resulted in proceeds of $1.75 billion and was used to reduce debt, with Vector's gearing decreasing from 59% to 36%. Our interest in Bluecurrent is accounted for as an investment and an associate with our 50% share of their net earnings reported below adjusted EBITDA. Bluecurrent has arranged debt facilities to fund the future rollout of meters. The shareholders have agreed to distribute a minimum of 85% of free operating cash flow. For FY '24, we expect to receive a cash distribution of between $40 million to $50 million from our 50% investment in Bluecurrent. This will be reported in our cash flow statement, not in our profit and loss. The business' operating performance is currently ahead of expectations, and the total meters deployed is 2.48 million at 31 December. Slide 10, which looks at gross CapEx. Total capital expenditure in the first 6 months was $238 million, up 6% on the prior period. Capital contributions were down 4% to $93 million, largely attributable to lower residential subdivisions and relocation work. Lower residential subdivision activity could be expected to flow through to lower future connections. The year-on-year increase was driven by an additional $31 million of replacement CapEx on the network. The next slide looks at the group debt. Debt and gearing has fallen since the sale of the 50% interest in Bluecurrent. Remaining proceeds from the transaction are currently on term deposit and will be used to repay the wholesale bonds due later this financial year. Looking at the segment performance from our Regulated Networks. Electricity revenue was up $15 million due to an increase in net connections, combined with higher volumes and price adjustments. In the year to 31 December 23, total electricity connection numbers grew by 2.2%, with new electricity connections for the 6 months up 12.5% on the comparative period in the prior year. Auckland's growth has continued, and we've seen 8,857 new electricity connections in the 6 months to 31 December, a record number for a 6-month period. Slide 14 is looking at the similar performance of Gas Trading. Adjusted EBITDA in the Gas Trading segment was $13 million. LPG volumes for the 6 months are up 8.3% compared to the December '22 period due to higher bulk sales. Bottle Swap has seen a 2.3% increase in the number of 9 kg bottles swapped in the 6 months to 31 December compared to the same period in the prior year. And Liquigas LPG tolling volumes are down 3.1% on December '22 comparative period due to lower customer demand. We are also now classifying our Natural Gas trading business as a discontinued operation as we've entered into a conditional agreement to sell the remaining assets of this business. The volume of gas traded has been reducing over recent years, as legacy contracts have come to an end. We've said for a number of years, we are winding down this business as we've consumed all our historic legacy gas. We expect the sale to complete on 1 July '24 for a sale price of $9.7 million. Now I'll hand back to Simon.

Thanks, Jason. Before I get to our guidance for the full year results, I want to comment briefly on the overall market. We know there is a significant need to invest more over the coming years to help the national transition to electrification, decarbonization and climate resilience, and this applies, obviously, to Auckland. Later this year, the Commerce Commission will decide on the allowable revenue for our regulated electricity business to take effect from 1 April 2025, which will then be locked in for the next 5 years. This is known as default price path 4 or DPP4. Vector's focus is on the interest of our customers and our aim is to invest in the smartest and the most efficient way possible to enable the energy transition in a way that's more affordable for customers as well as being commercially viable. While significant investment is needed now, our strategy uses digital, international partnerships such as with Amazon Web Services and innovation to get more out of our electricity network rather than only building traditional infrastructure. We will keep advocating for regulatory and policy changes, which, alongside our strategy, have the potential to avoid around $3 billion of extra cost to Auckland consumers by 2025 (sic) [ 2050 ], as we've set out in our TCFD report last year. That's $3 billion worth of extra expenditure, which would translate through into price to customers. Our future revenue and the debt we can raise determines how much we can invest in the network. The Commerce Commission's decision is, therefore, critical for our customers, shareholders and for the future of our electricity network. Globally, there's recognition of the need to make these decisions with pace and urgency. The opportunity for the Commission is to create the right environment for Vector and other lines businesses to invest enough in energy infrastructure to ensure we are not left playing catch-up years down the track when resilience, electrification and decarbonization are even more critical and when the cost building on consumers could be prohibitive. The special context for the Commission's decision this year is the interest rate environment and how much it's changed since the current revenue allowances were last set in 2019. Interest rates at that time were significantly lower, and those low rates were reflected in the revenue we've been receiving in the current DPP. Since then, interest rates have increased significantly, and this is recognized in the Commerce Commission's input methodology, which is used to set the new revenues limits for EDBs in the next defined price path, but obviously, alongside capital and OpEx allowances. I'll talk now about guidance for the full year. We're now tracking towards 16,000 new electricity connections for the year. As you've seen and heard, connections and infrastructure activity remain elevated, necessitating significant capital expenditure. We provided adjusted EBITDA guidance of $350 million to $365 million in August, and we are currently tracking towards the high end of this range. The Commerce Commission finalized the Input Methodologies Review in December '23. It is currently consulting on the next default path, DPP4, and how this transition will occur. DPP4 covers the period from 1 April '25 to 31 March 2030. The key impact will be the increase in weighted average cost of capital as a result of the change in interest rates going from 1.12% in the last reset, when rates were at historic lows, to 4.6% now. This determination will have significant impacts on the timing of Vector's revenue, subsequent investment levels and investor returns. Just like to briefly thank all the team and their crews out in the field for all the work they've done over the 6 months. And now I'd like to hand back to Doug.

Thank you, Simon. Could I just go back where I think you might have said 2025 when you meant 2050?

I'm sorry. Yes.

The capital avoidance of around $3 billion of extra cost to customers by 2050, as we've set out in our TCFD report.

Sorry, Doug.

Yes. Thank you. The Board has determined an interim dividend of $0.0925 per share with no imputation. The increase in dividend is to mitigate the impact of the loss of imputation credits. As we mentioned in our market release, key regulatory decisions impacting our future cash flow have still yet to be determined. And so the Board has been unable to consider an updated dividend policy. These key regulatory decisions are the same ones Simon was talking about, the revenue allowance under the DPP4 reset. We expect to have a better understanding of this by August, although the Commission's final DPP4 reset decision will not be released until November. There are a number of milestones along the way to a final decision and Vector will be engaging fully with the Commission throughout this process. That brings us to the end of our presentation. And just before we move to questions, I'd like to thank Simon and his executive team and everyone else at Vector and our field service providers on behalf of the Board for their hard work over the period to deliver for Vector customers and shareholders. Simon, Jason and I are now happy to take any questions.

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

A couple of questions from me. First of all, just interested in terms of the slight change in the dividend approach going fully unimputed and as opposed to partially imputed. And then second part of that question, I guess, is are you able to give us an indication of when you think imputation credits might be able to be -- come back on to dividends?

Yes. So the first question, Andrew. We have -- Vector has a accumulated tax assets on its balance sheet that it intends to utilize before it starts imputing dividends again. So that was the reason for the change. In terms of how quickly it will take us to use those tax assets really will depend on the reset decision and the Commission -- the amount of revenue the Commission will give us and, obviously, the earnings that flow out of that. So it's hard to have a view on that until we get our final DPP4 reset. But maybe 2028 sort of time frame, but we'll have to wait until the reset.

Yes. Okay. And I guess the second question, I guess my numbers sort of suggest, given the CapEx profile, I guess you might be challenged to get back to fully imputed dividends, just given the depreciation tax yield is -- that's a reasonable assumption to work with.

Look, our internal forecast, again, depending on where the reset gets, does have us returning to tax paying later in 2028 type of time frame. So that's not what we are currently forecasting.

Sure. That's sufficient to fully impute the dividend again at that point? Or more likely to go back to some higher sort of [ passing ]?

The policy will change to distribute the tax we're paying. My recollection is we end up becoming full taxpayers eventually.

Okay. Okay. Second question is just around, I guess, the capital contribution number. And I noticed the comments around fewer subdivisions. But I guess there was a little bit of a surprise for me given the strong connection growth. Do you have sort of much visibility for what we're looking at for the second half of the year around capital contributions?

It has been slower in the first 6 months in terms of just the amount of subdivisions and relocation work that's been going on. Sort of it's a bit about outside our control. And the connections you see are sort of a lag from the work that was happening probably 18 months ago to 2 years ago. So we haven't seen that pick up yet, but again, it's sort of outside of our control.

I think -- sorry, Andrew, I think the point Jason's making is, is that the capital contribution, we get that as the project starts, but the connection typically happens a year to 18 months later. So that's where that timing difference arises.

And there's a couple of large point loads in Auckland that have been delayed that are scheduled to come, but they'll probably come in early in the next financial year, I believe. So it's just -- it's -- again, it's just subject to some of these loads connecting and starting the work associated with those connections.

Yes. Yes. Okay. Next question I just had was on the natural gas business that's being sold. I mean, I guess, relative to the EBITDA for the half, the prices are, I guess, relatively low. Is that because I assume that there was a fairly significant drop-off in volumes you're expected to be in that business. Although, I guess, the remaining size of the book at the end of this financial year, is that the best way to think about it? Or is there something else in there?

That's right. Yes, Andrew. No, the book's been winding down actually over the last 3 or 4 years. So as we've been trading out of that book and haven't been -- mainly because we haven't had access to attractive gas been renewing those contracts, so it just reflects a wind down of the book and the last assets are being sold at the end of this financial year. So it's been a profitable business for Vector over time.

Yes. Yes, yes, indeed. Yes. Yes, I hate to think what it was go back about 10 years ago, it was quite attractive. Are you able to say who the buyer is?

No, I think we need to consent to do that.

Okay. And last question for me was just on the net interest. I just noticed there's quite a big difference, I guess, between the cash interest and the cash flow statement and the interest, which is much lower in the P&L. Is there some sort of big noncash item that's gone through this half? And is that sort of expected to continue?

There are some accrued interest associated with Bluecurrent. It could be that just off the top of my head that's been paid post 31 December. So could be that accrual. I'll come back to you on that.

Your next question comes from Phil Campbell at UBS.

Yes. Just a few questions from me, Jason. Just on the metering numbers, they're a bit higher than what I was going for. It looks like the variances in New Zealand. Is that like an acceleration of the Genesis meters? Or is there something else going on there?

Not that I'm aware of. I know we are deploying some smart meters for another party in New Zealand that would be part of it. So it's part of a smart gas meter rollout. That could be part of it.

There's nothing new contractual-wise in New Zealand. That's just basically probably just the timing that there's some -- I guess, as we note there, that it's performing well and performing at expectations and slightly better both here and IN Australia.

Right. In terms of the -- obviously, the dividend that's coming back, your portion of it, the $40 million to $50 million. Can you -- is that assessable for tax purposes? And kind of what will be the ongoing? Or are we assuming that number's going to grow? Or is that kind of -- is there some one-offs which make the number a bit bigger this year? What's the kind of guidance on that?

So the structure is complex as New Zealand and Australian companies, which both have different tax arrangements. We receive income in New Zealand but have tax assets in New Zealand, so that's helpful. We expect -- well, the forecast to continue deploying meters. I expect if that gets delivered over time, then those distributions should increase. The key thing that's driving that distributions is that the company has a debt facility to fund the rollout of its meters, and that's enabling it to distribute its operating cash flow. So as the numbers of meters that are deployed grows, the distributions to shareholders should track that.

Great. And then I noticed that IntelliHub had purchased I think Downer. Is the metering business -- is there other metering businesses out there that Bluecurrent could look at acquiring as well? Or is it going to be pretty much organic?

Yes. Well, I mean, I guess, with regards to metering businesses per se, there's -- that there has been consolidation. We've seen that more and more over time. I think the bigger focus is more around the available contracts primarily in Australia. And we're really pleased with how that's tracking in Australia now. There's -- obviously, from time to time, some people may have a different view around whether they want to hold metering assets or not. But as it stands at the moment, I think the primary focus is on contracting with customers. And if a entity did decide to look at divesting its assets, then, obviously, with our partners, QIC, and our balance sheet capacity, we've got every ability to enter into that process as well.

Is there any update on the Australian accelerating the fast meter rollout? I think they've agreed it in principle and they've got to look at changing some rules. Is there any update on how that process is going?

Yes, then that's basically now AERs basically identified they want the rollout of smart meters by 2030. So that's what everyone's working to in Australia now.

Yes. Okay. Awesome. And then maybe just the last one for me, just in terms of the ComCom decision on the finance-ability, like what -- do you know what the consensus is? Because obviously, you've got I think it's a revenue cap of 10% in 1 year. Like is there kind of an expectation amongst yourselves and the other lines companies that there's a possibility that ComCom may allow you to increase by more than 10% in a particular year?

I'm not too sure whether you saw the finance-ability paper that just came out. We were obviously looking at -- looking forward to that with keen interest. But you may see in the paper that it doesn't actually go into any conversations about potential price caps or any potential kind of adjustments. We met with the Commerce Commission yesterday, and it would be fair to say that in that conversation, that's still a process that they're considering. And we have to put in our asset management plan for 31 March. And then in May, we're expecting draft decisions on what they're looking at for that price path change and how they will look at whether there's price caps or p-nought adjustments. But it would be just absolute speculation at the moment where that sits. But we would also note that one of the positive adjustments that were made by the Commission in the Input Methodology Review was that they identified that any price cap that was imposed on us would not be inclusive of Transpower, whereas that was historically the case where Transpower charges were embedded into our charges and we were kept at that. So if Transpower had a large increase, then we were squeezed out the bottom end. So we saw that as a positive step 4 by the Commission. But as I say, there's nothing in any of the material around what levels will actually arise and we'll wait for May, which will also be important because, obviously, there's a lot of expenditure required and the Commission will take that into account and their draft decisions looking at asset management plans and what the -- I guess, the robustness of those across the country, and they obviously all fall into the final kind of draft decisions before they make final decisions later in the year.

[Operator Instructions] Your next question comes from Stephen Hudson at Macquarie Securities.

Simon, Jason, Doug, just three for me, if I could. Just on that last point, Simon, on your expenditure. I think you -- or the EDBs are being forced to share some interim asset management plans with the Commerce Commission prior to Christmas. Can you give us a bit of a feel for what you've shared with them in terms of particularly replacement CapEx, building and resilience expenditure and what changes we might see in the final asset management plan in April or whenever it comes out?

Yes. Stephen, with regards to our approach to the response to what was known as the 53ZD Notice, we're obviously updating that now because we need to do the asset management plan for March. But basically, I think the simplest way to respond there is there has been some increase in replacement and network expenditure, obviously, recognizing that most of the growth forecasts and that is funded through customers. So net CapEx. All in all, there's not a material adjustment based on that -- based on the 53ZD. There is some additional things like replacement of transformers, but we're not talking hundreds of millions. The issue is what -- the approach we've taken is with the topics that is actually driving some of the real big, for want of a better word, potential increases and capital expenditure and asset management plans across EDBs is what is the assumptions being made around resilience or what are the assumptions being made around EV growth. The approach we've taken is to say is that still a highly uncertain topic we've got with resilience? Kind of a few dimensions to that. One is that how do you work out what is the appropriate capital expenditure for a 1 in 250-year event or 1 in 100-year event? We've obviously identified that. But in identifying what additional expense that we could do to improve resilience for those extreme outliers, what we have also identified is that you could undertake, for example, undergrounding a whole lot of assets. But these assets typically lie in areas where there's a lot of overhead network and also vegetation and 65% of the impact through Cyclone Gabrielle came from vegetation. So we're awaiting decisions from [ IMB ] and this has been hanging around the hoop far too long that needs to basically say what is the decisions made on vegetation management because it's a materially lower cost to improve resilience than actually undergrounding assets, for example. As a result of that, what the approach we've taken with the Commission is, and we've foreshadowed this and we've discussed it with them, is saying, we're setting that level of resilience aside. We're identifying what the type of expenditure could be, what the different trade-offs would be? What would be the decision points that would enable those to go ahead, i.e., a decision around vegetation management or -- well, that's primarily it. And we would seek a reopener for that when there was more certainty because we're not minded to load up the asset management plan now with CapEx and then have that flow through into price increases to customers with a high degree of uncertainty. And pretty much the same dynamic with EVs. So with EVs, we're identifying what we think is a reasonable forecast, but it isn't like a high-growth forecast. And so we're also ring-fencing that out and saying that we would seek a reopener. Doug may want to comment, but we had a very constructive conversation with the Commission about that approach. And I think to be blunt, they appreciated that we were trying to identify those elements, but not take a view of loading them into the asset base, causing problems with regards to price impact on customers.

Yes. No, that's exactly right, Stephen. So yes, we're very mindful that these impacts on customer pricing could be very significant, yet we may not be spending that money anytime soon. So we're going to hold off. And the Commission were very positive around that course of action, but also flag to us what you might foreshadow that expenditure could be if you wanted to bring it forward. And then if we go for a reopener, they will have already had some forewarning and foreknowledge of where we are coming from, and we'd back it up with more detail. What they don't want is us just turning up out of the blue with a wish list of things we might want to reopen on. The problem with reopeners, as I understand it, I haven't been through the process of 1 yet, but there's no time frame attached to them. So we're looking for more certainty about from the time we submit when would we expect to get an answer. So the process of reopeners, we've still got to talk through with them and get more confidence in, but that's our approach at the moment.

That's useful, Doug and Simon. Just a couple of quick ones more for me. I think your risk-free rate gets locked across June to August. Will you still continue to hedge -- sorry, you won't hedge your debt book at that point like Transpower do, I suppose, that's one question to Jason. And then just another quick one. The move by the Commerce Commission on the potential WACC from P67 to P65, some people might take as neither here nor there, but others may sort of think it's a slippery slope and it's the beginning of the end point of P50. So just interested in your view there.

I'll deal with the hedging one, Stephen. So look, that's something that we are considering. It was a different -- quite a different balance sheet structure when we owned a large metering business. And when we become more heavily focused on regulated assets, then we will need to consider just how we manage that risk profile. So we haven't made that decision yet, but it's something that we're going to review.

I think it would be fair to say, though, when you look at the debt book, there's still quite a lot of debt that would be outstanding. And I guess that's -- I mean, it's a bit of a philosophical kind of conversation because I think -- well, certainly, we don't see most of the EDBs in the country and I think even suspect Transpower, they don't fully hedge all their position on those dates. And our kind of view would be that you couldn't go to the market to fully hedge it because you're just going to create a massive kind of rush of capital that wants to be kind of hedged and borrowed from. But that's -- be that as it may, I think the other point you raised was around the percentiles of the 67th going to 50th and so forth. Yes. Look, I think the 67th going to 65th is a minor adjustment, but I think it'd be fair to say that we have long maintained and the theory should be that there should be that 65th, 67th. In fact, most of our experts were showing it should be higher because of the investment requirements. That's something that obviously can't be adjusted now until the input methodology is 7 years on from now. But obviously, with the nature of long-term assets, that's something that we'll always have to be mindful about as would they potentially look to move that down. But as it stands at the moment, that's locked in for 7 years.

Your next question comes from Grant Lowe at Jarden.

Team, can you hear me okay?

Yes.

Great. Yes, I didn't -- well, while struggling through the results today, I haven't read anything about what's happening with the Corporate segment. I know that there was some softness in some of those business units in past results. Can you -- or recent results. Can you just touch on how those businesses are performing in the Corporate segment?

They're performing flat, I think, would be a summary. There's been -- yes, I mean, it's -- yes, we're talking about HRV. We're talking about the PowerSmart business that we've actually ceased operating at the end of the year. So again, that was marginal. So yes, it's a pretty flat result for the 6 months in those areas.

Okay. And obviously, tracking fairly well towards the top end of guidance. So those aren't a risk for the second half?

Biggest risk there is actually weather in terms of some of the things we can't control. So we learnt about that with Gabrielle last year. That had an impact on our full year results. So we're just mindful that weather does have an impact. We are also exposed on just input costs for some of the LPG that we purchase. Again, that's another exposure we have. So they're the 2 things that can move and impact our results in the second half.

Thank you. There are no further questions at this time. I'll now hand back to Doug McKay for closing remarks.

Thank you. If there are no further questions, we'll end the teleconference and the webcast. If analysts and investors have any further questions, please feel free to contact Jason. For media, please contact Matt Britton or call our usual media phone number. Thank you, everyone, for joining us.