Australia | Feb 04 2015
– Upgrade to guidance
– Surprise upgrade to dividend
– ENE repositioned as a yield play
By Greg Peel
The Australian longer term investor’s search for yield has not abated in early 2015. Indeed, on stock market performance to date, it has intensified. Yesterday’s rate cut from the RBA is only one accommodative move in a long line of global monetary policy easing, from increased Japanese stimulus to the ECB’s “shock and awe” QE and on to rate cuts in China and in many commodity-exporting countries.
Global interest rates are at historical lows, thus making dividend yields on listed stocks ever more attractive for those seeking income. “Risk free” government bonds and government-guaranteed bank term deposits just don’t cut it against inflation, thus “risky” positions are favoured in high-yielding stocks. Bigger, more solid and more consistent yield plays such as the major banks and Telstra are most popular, as are utilities and other vehicles offering stable income streams in a trade-off for any significant capital growth (and thus greater risk).
Energy Developments ((ENE)) develops and operates power generation projects across Australia, Europe and the US, sourcing both traditional fossil fuels but also “greener” alternatives such as landfill gas and waste coal gas. The company thus sells both electricity and what we can loosely call “carbon credits” across various state and nationally based schemes.
Late last week Energy Developments pre-announced an unaudited first half earnings result, ahead of its official result due on February 24 (according to broker calendars). The release was accompanied by an upgrade to full-year earnings guidance to $205-210m from a previous $192-202m. The bulk of the upgrade related to a stronger performance domestically, reflecting the benefits of the company’s Envirogen acquisition, higher Queensland electricity pricing and stronger Renewable Energy Certificate (REC) prices.
The first half result itself is not as important as the increased guidance. Alongside the upgrade, Energy Developments announced an increase in first half dividend to 20c (75% franked) from a previously flagged 15c (100% franked). In so doing, ENE has become a “yield play”.
Dividend increases are a two-edged sword, given the money distributed to shareholders has to come from a pool that would otherwise be used to fund growth options. If we look at Woodside Petroleum ((WPL)) for example, that company’s now famously high yield (for a resources company) is all about a lack of available growth options. Now that it appears the sale of Queensland’s electricity assets is off the cards, alongside a general slowing down of the resource sector, Energy Developments has also found its growth options to some extent diminished.
So the board has decided to reposition the company as a slower grower but higher yielder, making the shares more attractive to aforementioned stable income seekers. Despite a big jump in the share price on the announcement, analysts are forecasting around a 7% FY15 dividend yield. Macquarie calculates the new payout represents about 85% of operating cash flow after minimum capex requirements are taken into account. So there remains room for incremental growth options to be pursued. It’s just that medium-term growth has now been restricted.
Longer term growth potential is not lost, however, on the assumption one day the resource sector will rise again.
A critical element of Energy Developments’ revenue expectations is the value of Australian Carbon Credit Units (ACCU). Given uncertainty with regard federal government policy, UBS, for one, had omitted any ACCU income from its valuation model as a conservative measure. But since the passing of the Emission Reduction Fund legislation, UBS is now happy to reinstate its ACCU expectations.
Just what might an ACCU be worth? Energy Developments’ management has suggested $12/unit. This surprised Macquarie, who had previously modelled on $3/unit. UBS is happy to plug in $12 but all will be revealed when the first auction is held on March 15.
The higher dividend merely changes Energy Developments total return mix to more income and less capital growth, Morgans suggests, but “ENE will excite investors looking for strong dividend yield and growth”. Macquarie agrees that in the current environment, the step-change in dividend is attractive to investors even though growth may slow.
UBS calls Energy Developments “The new yield play”.
Six FNArena database brokers cover ENE and all carry Buy or equivalent ratings. The consensus target price now sits at $6.34, up from $6.05 pre-announcement.
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