Diversifying in search of dividends

Part two of a series on New Zealand's largest share float: how Contact will manage risk to reward shareholders. MARK REYNOLDS reports

Contact Energy has a five-pronged strategy to combat an expected increase in competition in electricity and gas markets this year.

The strategy is in large part designed to confront heightened competition in the electricity market following the split of ECNZ into three separate and competing units - Mighty River Power, Genesis Energy and Meridian Energy.

Contact's five-part plan involves winning more share of current electricity markets, creating new electricity and gas demand, reducing wastage of Maui gas payments, making existing power plants more efficient and controlling overall costs.

The plans are outlined in the prospectus for a sale to the public of 60 per cent of Contact. All of the strategies are underway, and most have been running since Contact was itself split from ECNZ in early 1996.

At the time of the split, Contact produced power from eight electricity stations, including a gas-fired New Plymouth plant and hydro-powered facilities at Clyde and Roxburgh.

In early 1996 Contact sold all of its electricity to ECNZ, but a competitive wholesale market for electricity was established in October 1996 and that allowed Contact to compete with other suppliers for customers.

Contact now owns more than a quarter of the nation's electricity generation capacity, and therefore is in a good position to manage its various facilities in order to get the best price on wholesale prices.

To make sure it stays ahead of the new ECNZ companies, Contact plans to tie up other electricity retailers and large electricity users with exclusive contracts. That might involve longer-term supply alliances with industrial users like the New Zealand Co-operative Dairy Company. Contact is already building a gas-fired power plant at Te Rapa in association with that company.

Such deals will help minimise exposure to the vagaries of spot prices on the electricity market. Contact also plans to extend its retail electricity customer base, which will give it an assured market for the electricity it produces. Over the past six months Contact has paid $134.3 million to secure a base of 246,000 retail electricity customers, including people who were formerly customers of companies like Top Energy in Northland and United Electricity in Dunedin.

The Contact prospectus says the company will now strengthen its retail market share through organic growth, in part by offering a better price than its customers because of its ability to sell power direct from its production plants. It also plans to cross-sell electricity to its retail gas customers, and vice-versa.

Contact has about 105,000 retail gas customers, most of whom it took over after purchasing the retail gas operations of Enerco for $88.2 million. Expansion of those gas sales appears to be a big part of the companies future earnings hopes.

"Contact aims to further diversify its revenues through further targeted growth in new generation projects, including co-generation, and expansion of gas sales to industrial users within New Zealand and by targeting potential international business expansion."

Contact will supply gas to customers mainly from the Maui field off the coast of Taranaki. The company has rights to buy more than two fifths of the gas that comes from Maui each year. Its contract to buy the gas is on a take or pay basis, and in recent years it has actually had to pay for gas it has not been able to use.

"Contact aims to reduce the gap between the company's utilisation of gas and its financial obligations under its gas purchase contracts," the prospectus said.

That will involve renegotiating the contract with the government, which might require court action.

Regardless of how the gas negotiations go, Contact believes it can improve its performance for shareholders in other areas, such as making its plants more efficient. The completion of the new Otahuhu B power plant in South Auckland - which will be capable of supplying 5 per cent of the nation's power needs - is part of this strategy.

Contact also has plans to upgrade facilities like the Wairakei and Ohaaki geothermal stations. Any upgrades will require resource consent changes and agreements with local Maori interests.

The company is sure it will be hit by competition this year, and in fact expects overall profits in its September financial year to slip to $65.5 million from $80.3 million last year, mainly due to wholesale electricity competition.

But it is confident that by diversifying its customer base, sales will rebound to $887.8 million in the year 2000 from a forecast $795.6 million this year, and that will allow net profit to recover to $78.4 million in the year 2000.

Earnings before tax are forecast to slip to $69.4 million this year from $114.7 million last year, but are expected to be $119.5 million next year. On a per-share basis, earnings will be 10.8 cents this year before rising to 13.0 cents next year. That will allow a dividend of 8.7 cents a share to be paid this year, rising to 10.3 cents next year.

For new public shareholders in Contact, the first tangible reward from their investment will be the company's dividend for the final half of this financial year, which is expected to be paid out in December.

That dividend payment is forecast to be about 3.9 cents a share, which at a sale price of $2.50 a share would represent a pre-tax return of 2.4 per cent for the six months, or 4.6 per cent on an annual basis. At a sale price of $3 a share the return would be 1.3 per cent real for six months, 1.9 per cent at the top tax rate and 3.9 per cent on an annual basis.

In the first full financial year public investors will own shares in Contact, the dividend is forecast to be 10.3 cents a share. That represents a 6.3 per cent return on a pre-tax basis at a share price of $2.50, or 5.3 per cent at a share price of $3 each. The prospectus notes that Contact's policy will be to return 80 per cent of profits to shareholders by way of dividends. The intention is to grow overall dividends over time.