Meridian float backed by researchers

Meridian's Te Apiti Wind Farm on the Tararua Ranges.

Independent research house Morningstar has come out in favour of the upcoming Meridian Energy float, saying it was likely to appeal to long-term investors seeking yield.

But Morningstar said the company, which accounts for 30 per cent of New Zealand's electricity output, would be susceptible to political change and the weather.

Independent valuations from Morningstar ($1.75), Wellington-based investment bank Woodward Partners ($1.81) and TDB Advisory ($1.70) were all at the top end of the Government's final price range of $1.50 to $1.80.

Brokers First NZ Capital, which is not involved in the partial privatisation process, was more conservative. Applying Contact Energy and Mighty River multiples would indicate a fully-paid trading range for Meridian shares of between $1.43 and $1.60, with a $1.51 midpoint, First NZ said.

All four valuation reports published to date pointed to the risks associated with the Labour/Greens' plan to take control of the electricity market, but ascribed less risk to the possibility Meridian's biggest customer, the Tiwai Point aluminium smelter, pulling out.

Morningstar said Meridian had a narrow economic "moat" due to cost advantages and the fact that New Zealand's small population creates barriers for would-be new entrants.

"Accordingly, we expect Meridian and the other incumbent energy providers to generate solid returns, above the cost of capital, over the long term," it said.

"That said, from time to time, Meridian will be impacted by adverse hydrological conditions due to deficient rainfall and/or inadequate snowmelt," Morningstar senior equities analyst Nachi Moghe said in the report.

Meridian gets its power from renewable sources - hydro and wind. Unlike its competitors, it does not have thermal assets. That meant the firm's margins and earnings would continue to be more volatile than its peers, the reports said.

Apart from operational risks, there was the potential for regulatory change with the New Zealand opposition Labour Party's plans to regulate electricity prices through a single-buyer model.

"We believe regulation would most likely reduce returns for all power companies and possibly reduce Meridian's operating income by $170 million, all else being equal," Moghe said.

"We believe the Opposition proposal is fairly extreme but it would significantly reduce our fair value estimate if implemented," he said.

The Government has capped the issue price for retail investors at $1.60 per share provided they keep their shares until May 2015. Also, investors will only have to pay an initial instalment of $1.00, with the balance payable in May 2015.

Meridian would offer an attractive dividend yield, Moghe said, but unlike Mighty River Power, the company's dividends would not be fully imputed.

"However, in the context of what we regard as a stretched New Zealand market, the capped price appears reasonable value, hence our recommendation to subscribe to the offer," Moghe said.

TDB Advisory said its analysis of the risk profile of electricity generator-retailers, including Meridian, indicated it would be a mistake to regard the companies as being utilities with stable earnings.

"These companies, and Meridian in particular, face and must manage a high degree of uncertainty about water inflows, other fuel prices, the regulatory regime and competitors' behaviour," TDB said in its report.