ERM provided guidance around FY16, with the reiteration of previous $81-
85m EBITDAF and a sustained dividend ie ~$12m. At the same time, whilst
not explicitly providing FY17 guidance, we estimate overall EBITDAIF falls
5%, with the US investment propping up the performance.
Impact
Australian Retail has hit a brick wall. 2H Australian volumes for the first time
since listing are expected to be lower than 1H. Competition is stronger, but
volatility re-emerging has shifted the advantage to the Gentailers. This
pressure on gross margin has surprised us with a collapse from +$4.50/MWh
over six years to $3.00/MWh (MRE $3.75/MWh) in FY17. Diversification to
SME has provided no obvious protection.
Oakey operating strategy (not disclosed) was caught by market outcomes.
Volatility was favourable with hours above $100m, double last year. The
difference is last year Oakey benefited from LNG tolling income, vs. this year
that does not look like it has repeated with plant operating hours down more
than 50%. Impact is disappointment in FY16, and management flagged FY17
will be tough as the plant has a 45-day outage. This is 3 years ahead of our
expectation with a capital cost of $15m.
The saviour is the US result. Its sales growth is consistent with expectation at
5TWh (FY17, MRE 6TWh), but the gross margin is forecast to lift 50%. Whilst
slightly below MRE expectation, operating cost growth is materially better.
However, the US improvement of $8m (lower currency than guidance) is not
enough to offset the Australian decline of $33m ie 38% of earnings.
Earnings and target price revision
We have downgraded our earnings estimate by 48% in FY17, with earnings
now down below FY16. Cash management has been a strong feature of ERM
with the Sunset Power deal, EGO sale and redemption and the Liberty deal,
however sustaining the dividend at $0.12 is questionable; we have dropped
FY17 expectation to ~$0.08 ps equivalent to earnings.
Price catalyst
12-month price target: A$1.09 (down from A$1.93) based on a NPV rolled
forward methodology.
Catalyst: The low share price may spark corporate activity, otherwise margin
stability in the Australian retail business
Action and recommendation
Underperform, with a revised price target of $1.09. The collapse of the retail
margin will raise questions around sustainability of the business, along with
predictability, thus adding risk to the investment. US growth will get tarred with
the same brush until cash flow is established. Yield at 7.3% in FY17 should
provide some floor to the share price, along with the allure of potential
synergy benefits with a 3rd party already in generation. This creates a floor,
but little catalyst for a re-rating.
