Broker goes back to the drawing board after Rio Tinto keeps Tiwai open

Rio Tinto’s decision to extend the life of the Tiwai Point aluminium smelter to at least the end of 2024 is seen as a significant positive for New Zealand’s power generators, but some are expected to benefit more than others.

The Anglo-Australian metals and mining giant last week said it had reached a deal with NZ Aluminium Smelters’ (NZAS) biggest electricity provider, Meridian Energy, that will keep the facility open, after earlier threatening to close it by the end of August.

Contact Energy will also provide 100 megawatts of baseload electricity for the plant – which requires 572 megawatts – for the period.

The threat of Tiwai’s closure has been hanging over the sector for more than a year, although electricity price futures have for some time been trading as if nothing was going to happen.

Likewise the share prices of the main power generators have been buoyant, even more so early this month after a wave of buying from exchange-traded funds (ETFs).

Forsyth Barr said with Meridian Energy providing the bulk of the discounted power to the smelter as part of the deal, it had the least upside, while Genesis Energy, which runs the coal and gas-fired Huntly Power Station, stood to gain the most.

“It [Genesis] is also our preferred electricity sector stock, being the only one with an ‘outperform’ rating as we are downgrading our Contact Energy rating to neutral following its recent strong share price performance,” the broker said in a report on the sector.

“It has the largest mass-market retail customer base which will no longer be targeted by Meridian Energy and was long gas until the Kupe contract ends in 2024.”

“These are no longer issues, hence the material forecast uplift,” Forsyth Barr said.

With Genesis’s high gearing, a decline in earnings if NZAS were to close would have significantly impacted its ability to pay a dividend.

“That decline now reverses, and we assume Genesis’s dividend continues its gradual inflation increase above 2020’s 17.2cps.”

One of the advantages of NZAS remaining open for longer is it enabled Genesis to control the transition away from its thermal fuels.

All the sector’s medium-term earnings forecasts would increase as the broker rolled back NZAS closure implications from its forecasts.

“All of our dividend forecasts are also increasing, with Genesis, Mercury and Trustpower back to pre-July 2020 trajectories.”

Contact’s 2021 dividend forecast of 36 cps reflected lower short-term earnings due to the electricity price discount it is providing NZAS.

Similarly, Meridian’s full year 2021 ordinary dividend forecast of 17 cps is flat on FY20 “and we no longer assume a special dividend”.

Rio’s decision means there is more certainty around electricity sector dividend forecasts than there has been for about 15 months.

Forsyth Barr said Rio may well try to extend the deal beyond 2024, possibly on current terms.

The key task for Meridian and Contact was to find additional power demand in the lower South Island, should Tiwai eventually close.

“We believe there is a good chance NZAS will remain open beyond 2024, with environmentally friendly aluminium becoming increasingly important,” Forsyth Barr said.

Brokers have also noted a 14 per cent lift in aluminium prices over 2020, which may also influence Rio’s thinking if it is sustained.

In a separate research note, Harbour Asset Management said Rio’s move would provide the companies an element of certainty over cash and dividends which it expects further confirmation of in the February reporting round.

“The price movements of the sector and, in particular, Meridian and Contact Energy in the last six months has been principally driven by Clean Energy ETF fund flows rather than any change in the profitability of the companies,” it said.

As such, share valuations in some sense had already captured a lot of the good news, it said.

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