Small Caps | Apr 03 2017
Success with its strategy has meant power retailer and generator, ERM Power, is able to upgrade guidance for FY17 and provide a better-than-expected outlook for FY18. -Reduced competitive pressure as wholesale electricity prices rise
-Benefit from in-the-money contracts and hedge book
-Brokers envisage long-term value if pricing and offtakes align
By Eva Brocklehurst
Power retailer and generator, ERM Power ((EPW)), has pulled off a win in the complex and volatile electricity market. The company has revised its FY17 gross margin outlook to $3.50/megawatt hour from $3.00/MWh and provided FY18 guidance of $3.50/MWh.
This FY18 guidance compares with Macquarie's original estimate of $2.70/MWh. The broker finds predicting the company's retail business challenging, as visibility is low and a function of the company's hedge book. In just one month, following first half guidance, there has been a positive swing of around $9m pre-tax. As load contracts are already written, the primary variable is the cost of supply.
The broker suspects the company has obtained a benefit of being long power over the Queensland summer and that it covered some of the Callide C coal-fired power station hedge when one of the participants went into administration, but with the hedge actually not being closed out. Macquarie estimates the gain could be as much as $4-5m.
The other driver of the improved guidance, the broker suspects, is likely to be the hedge book, which has performed favourably relative to customer demand and market volatility. What is less clear is how the guidance affects later years, which will be a function of contracting.
Over the medium term, Macquarie's forecast remains at the lower end of the company's annualised $2.60-4.00/MWh gross margin range. The upside offset will emerge if the capital intensity of the business diminishes. All up, Macquarie finds enough positives to upgrade to Neutral from Underperform. The broker calculates a minimal premium is being paid for the stock.
Citi also upgrades, to Buy/High Risk from Sell/High Risk. The broker believes the guidance upgrade is because of reduced competitive pressure in the commercial and industrial (C&I) market as wholesale electricity prices rose, while volatile prices created opportunities within the hedge book, with the company coming out ahead.
The exit from administration of a party to the Callide C joint venture means ERM obtains cheap wholesale purchase contracts, struck before the recent run-up in electricity prices, versus much higher current costs. The broker believes the company's strategy has paid off, with high electricity prices and state government support continuing to move renewables projects forward.
That said, Citi cautions that this is not always the case and cost blow-outs are experienced every once in a while, but at this point in time the risk is well factored in at current share prices.
EPW Price at posting:
$1.33 Sentiment: Buy Disclosure: Held
