ERM Poised To Hit Power Switch
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ERM is licensed to sell electricity in all Australian states and territories and is the fourth largest seller of electricity by volume in the National Electricity Market.
Energy services provider, ERM Power (EPW) has had a rough 2014, losing 27% of it share price value, but the consensus forecast of the analysts that follow the stock sees ERM recovering all of that ground. And there is good reason for optimism in its outlook after that.
Founded in 1980 as a boutique energy consultancy, ERM evolved into a power station developer in the mid-1990s when it saw opportunities in power generation arising from the privatisation of the electricity market. ERM has invested more than $6 billion to develop six low-emission gas-fired power stations, which now generate more than 2,000MW of electricity: the stations are Oakey, Braemar 1 and Braemar 2 in Queensland, the Uranquinty power station in New South Wales and the Kwinana and Neerabup power stations in Western Australia, which in total represent about 5% of Australia’s grid-connected generation capacity.
Of these, ERM owns 83.33% of Oakey and 50% of Neerabup, generating 497 megawatts a year of power on its own account. The company also operates the 320MW Kwinana baseload power station in Western Australia for NewGen Power.
ERM is licensed to sell electricity in all Australian states and territories and is the fourth largest seller of electricity by volume in the National Electricity Market. The company focuses on selling electricity exclusively to business customers, with this segment of the market comprising approximately 12% of all customers and 70% of all electricity sold in Australia.
ERM’s strategy was to diversify into electricity sales and gas exploration to protect and supplement its generation business. In 2007 it established an electricity sales business, ERM Business Energy, to sell electricity to large customers in the commercial and industrial (C&I) segment of the market. At present ERM has a 13% share of the C&I market.
The decision to diversify into gas exploration was rewarded in 2010 and 2011 when ERM made successive commercial-size gas discoveries in the Perth Basin of Western Australia, culminating in gas and condensate sale agreements with Alcoa and BP. The gas business became a producer with the commissioning of the Red Gully gas and condensate facility in Western Australia, starting in July 2013. The gas goes to Alcoa’s three WA alumina refineries, and the BP refinery at Kwinana, through the Dampier to Bunbury Natural Gas Pipeline (DBNGP). ERM Power owns 23.6% of the Red Gully joint venture, with Empire Oil & Gas (EGO) owning a 76.4% interest.
The company has successfully transformed itself from an electricity generation business to one powered by electricity retailing – buying electricity from power suppliers and selling it to users.
In the latest result, for the half-year ended December 2013, revenue rose by 35.5% to $970.1 million, but net profit fell 49.8% to $13.3 million. Electricity sales revenue increased 37% to $929.9 million.
Capitalised at $413 million, ERM Power has been listed on the ASX since late 2010. In that time, electricity sales have grown consistently, from $5.6 million in FY11 to guidance of $14 million for FY14 (and $17 million in FY15). Underlying net profit (excluding significant items) has grown from $3 million in FY11 to $20 million in FY13, and the ERM has told the sharemarket to expect a final figure of up to $22 million for FY14, and between $30 million–$33 million in FY15.
However, that represents an 8% downgrade to FY15 guidance, which the company attributed to weaker margins in its business, slower than expected acquisitions of small customers and delays of its move into gas sales. When the company issued the downgrade, in April, ERM Power shares dropped 35 cents, or 15%, to $1.98.
It was a capricious reaction from the sharemarket, because in the same breath the company reported its biggest deal to date, $1 billion worth of new contracts to supply electricity to the federal and NSW governments. The deals were a $900 million three-year agreement with the New South Wales government and a $100 million extension of an Australian government contract.
Commencing on 1 July 2015, the NSW government deal covers electricity supply to more than 15,000 sites owned by NSW Health, the department of Education and Attorney General and Justice. The federal contract covers power supply to more than 80 commonwealth agencies including the Department of Defence (in the ACT & NSW), Parliament House, the Australian War Memorial, and the National Museum.
Also in April, ERM signed a contract with 18 Victorian councils to supply power to more than 2,000 large and small sites, including street lighting.
The sharemarket was already disappointed at the failure of ERM’s bid for the Macquarie Generation assets – the Liddell and Bayswater power stations in the Hunter Valley, which produce more than a quarter of NSW's energy. The company lost out to AGL Energy, resulting in bid costs of about $5.5 million, which will be expensed in the current financial year. The failure of the Macquarie bid caused FY14 net profit guidance to come down from $23 million–$26 million to $19 million–$22 million.
It looks like an over-reaction on the part of the sharemarket. The consensus target price for ERM of the analysts that follow the stock is $2.40, well above the current share price of $1.735. On consensus forecasts, ERM is trading at 13.4 times expected FY15 earnings and a fully franked dividend yield of 7.6%.
The company has strong contracted sales. Electricity is sold in 2.5 to 3-year contracts, which are signed well in advance of start date. Just over three-quarters (76%) of ERM’s FY15 forecast sales have been contracted – this is 25% higher than FY14 contracted sales were at the same time a year ago. Full-year FY15 forecast sales are 21% higher than FY14 forecast sales.
The sales business has grown strongly and shoots the lights out on customer satisfaction: ERM has been independently recognised as the leading electricity retailer to business customers, with record levels of customer satisfaction. In 2013, ERM Power started a specialist operation retailing to the small and medium-sized enterprise (SME) market, which has never had a dedicated power retailer. ERM’s excellent track record in customer satisfaction should help it do very well in the SME market – which has very healthy profit margins. ERM’s big opportunity is the 87% of the business market it does not have – it looks to have plenty of room to grow.
James was founding editor of Shares magazine, and oversaw one of the most successful magazine launches in Australia. He has also written for BRW, Personal Investor, The Age and Management Today, and was subsequently personal investment editor at The Australian and editor of financial website, investorweb.com.au