Contact needs dry weather and a change of chairman

Are we any clearer about Contact Energy's prospects after this week's high-profile annual meeting? In other words, did investors receive any new information that makes it easier to determine whether to buy, sell or hold the company's shares?

To answer these questions, we need to look at three specific areas. These are:

* The group's earnings prospects.

* The attitude of its 40.7 per cent shareholder, Edison Mission Energy.

* Corporate governance and investor relations issues.

Despite claims by chairman Phil Pryke that the company has exceeded profit expectations, Contact Energy's core earnings have been disappointing and below prospectus forecasts. The poor earnings performance has been a contributing factor to the low share price.

In the March 1999 prospectus, directors forecast EBIT (earnings before interest and tax) of $173.8 million and an operating net surplus (net profit) of $78.4 million for the September 2000 year.

Although the company reported an EBIT of $172.3 million and a net surplus of $97 million, both these figures contained a very high level of non-recurring, non-operational items. As most investment analysts and professional investors strip out these abnormal items, this left the group with an operating net surplus of $61.1 million.

The main reason for the poor operating performance was last year's warm and wet winter.

Contact Energy operates the Clyde and Roxburgh hydro power stations in Otago. In wet conditions, water flows into the southern lakes and storage increases. When storage is high, with regular inflows, there is greater available generation capacity and wholesale electricity prices fall. In warm weather, electricity usage declines.

Thus, Contact was hurt by low wholesale prices and reduced retail demand during the wet and warm winter of 2000. Its ideal situation is a dry and cold April to September.

One of the most disappointing aspects of this week's meeting was the unwillingness of directors to give any indication of trading results for the first quarter of the current year or their expectations for the full year.

The absence of any formal update of profitability has created some uncertainty because directors were trying to create a positive image and one would have expected them to release updated figures if they were better than last year's.

Although the full-year profit is extremely difficult to predict - because it depends heavily on winter weather - most analysts forecast a net operating surplus of more than $100 million for the current year.

If this can be achieved, it will have a positive impact on the group's share price.

The second issue concerns the financial problems facing the Edison International group in California.

Edison's difficulties go back to the deregulation of the state's electricity industry five years ago.

Legislation passed in 1996 encouraged Californian utilities to sell their generation assets and specialise in distribution.

Southern California Edison, which is 100 per cent owned by Edison International, sold its generation activities and returned $US4.8 billion ($10.7 billion) to its parent. Almost all of this was used to pay dividends and share repurchases for the benefit of Edison International shareholders.

No new generation plants were built in California despite a dramatic increase in electricity demand because of the technology boom and a number of hot summers and cold winters.

The shortage was exacerbated by the explosive growth of Las Vegas and Phoenix across the Nevada and Arizona borders which reduced the amount of electricity that California could import.

The generation companies increased their prices but the distributors operate under strict price control. The outcome was inevitable - the distributors were paying more for their electricity than they could charge their customers and were facing bankruptcy.

Edison International's share price plunged from nearly $US30 in January 2000 to $US6.25 last month. But this week the California legislature introduced measures, including a price rise, to help the distributors, and Wall Street turned bullish on the industry.

Southern California Edison's problems are not over but Edison International's share price has recovered and closed at $US13.45 on Thursday.

The two Edison Mission Energy representatives on the Contact board told this week's meeting that Edison Mission Energy had no liability to Southern California Edison. They assured shareholders several times that Edison was a long-term holder of its New Zealand investment.

It was reassuring to hear that Edison would not be a distressed seller but it is highly unlikely that the Californian company will make a full takeover offer while it continues to experience problems in its home territory.

Although Edison may not be a seller, domestic investors are bailing out of New Zealand's largest energy utility. The number of shareholders has fallen from 225,000 to 161,000 in less than two years. Over the past 10 weeks the group has lost nearly 70 shareholders each trading day.

This places consistent selling pressure on the stock and reflects the group's poor profit performance as well as shareholder dissatisfaction over remuneration and investor communications.

The day before Contact Energy's meeting in Auckland, Edgar Online, a division of the United States Securities and Exchange Commission, released a newsletter that was highly critical of Edison International's pay structure.

The letter argued that the Californian electricity utilities blamed their problems on out-of-control costs but for Edison International "one such cost could be executive compensation."

According to Mr Edgar, million-dollar bonuses are common in Silicon Valley, but they are rare in the electric utility industry.

However, Edison International's chief executive received $US2.2 million, including a bonus of $US1.3 million, whereas the top executives of other regional utilities were paid 25 to 50 per cent less.

The newsletter listed four large, east coast electricity utilities, with sharemarket values between $US7.4 billion and $US18.9 billion, where chief executives received between $US1.1 million and $US1.5 million, including bonuses.

By comparison, Contact Energy's market value is only $1.7 billion, but former chief executive Paul Anthony was paid $2.9 million last year.

The saga over the directors' fee increase is also having an impact on shareholder sentiment. The motion for a proposed increase was withdrawn even though each director told the meeting he supported the rise and there were enough proxies to carry the motion.

Why did directors withdraw the motion when they will probably ask for an increase next year and have to face the same public criticism?

Contact Energy's investor communications are still inadequate, although they have improved over the past year. The group accounts are difficult to understand and an analyst recently wrote: "Disclosure levels improved but the company's accounts remain very difficult to decipher, due to numerous abnormal items as well as the treatment of other operating items."

But the biggest problem is Mr Pryke's inability to relate to the mums and dads who purchased Contact Energy shares in the initial offering.

Mr Pryke was probably an excellent chairman when Contact Energy was Government-owned, but it takes a special ability to chair a company that has a huge number of individual investors.

Sir Ron Brierley had those skills; he listened to shareholders and talked to them at their level, whereas Mr Pryke has a fixed opinion on most subjects and tends to talk down to shareholders. This attitude has been reflected in the company's communications and has contributed to the loss of 64,000 shareholders since listing.

Although there were no great revelations, most shareholders left the Aotea Centre with the feeling that Contact Energy has good long-term prospects. In the short term, the company's share price will benefit from a dry and cold winter, better communications and the appointment of a new chairman.

* Disclosure of interest: none.
* bgaynor@xtra.co.nz