Tauhara And Te Huka 3 Geothermal Projects Will Improve Future Operational Efficiency

Key Takeaways

• Strategic divestment from thermal sources and renewable energy investments are anticipated to optimize fuel efficiency and reduce costs, boosting margins and efficiency.
  
• Operational ramp-up of new projects like Tauhara and Te Huka 3 is expected to enhance capacity, potentially leading to higher revenue, earnings, and dividends.
  
• Challenges in energy supply and regulatory delays could increase costs and financial risk, impacting profitability and revenue realization from new projects.

Catalysts

Generates and sells electricity and natural gas in New Zealand.

• The completion and operational ramp-up of the Tauhara and Te Huka 3 geothermal plants are expected to add significant additional generation capacity, contributing to increased revenue and alleviating supply constraints, which could improve future earnings.
  
• The planned commitment to new renewable energy projects, such as the Glenbrook battery and Kowhai Park, is expected to enhance EBITDAF by taking advantage of market volatility and improving the internal rate of return, thereby positively impacting net margins.
  
• The company's strategic divestment from thermal sources and the shift towards renewable energy is anticipated to optimize fuel mix efficiency and reduce operational costs, likely increasing net margins and operational efficiency.
  
• Potential increases in electricity tariffs are anticipated to align with transmission and network cost escalations, which could drive higher revenue in the retail segment by passing these costs onto consumers.
  
• As new investments such as Te Huka 3 and Tauhara operationalize, Contact Energy expects to sustain higher profits, leading to potential dividend increases, which may boost EPS and overall investor returns.

Contact Energy Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Contact Energy's revenue will decrease by 0.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 8.2% today to 10.4% in 3 years time.
• Analysts expect earnings to reach NZ$305.7 million (and earnings per share of NZ$0.38) by about February 2028, up from NZ$235.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as NZ$369.3 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 30.8x on those 2028 earnings, down from 31.6x today. This future PE is greater than the current PE for the NZ Electric Utilities industry at 30.7x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.29%, as per the Simply Wall St company report.

Contact Energy Future Earnings Per Share Growth

Risks

• The challenges faced with extreme low hydrology and low wind conditions, coupled with gas supply issues, could lead to higher operational dependency on thermal power, thereby increasing operational costs and potentially impacting net margins.
  
• The increased competition for gas resources, as seen with Methanex, may further increase gas prices and affect the cost-effectiveness of maintaining thermal operations, potentially impacting earnings.
  
• Ongoing execution risks around new project developments, such as issues with vibration in Tauhara, demonstrate potential operational setbacks that could delay revenue realization from these projects.
  
• The slow progress in regulatory reforms and resource consents can delay renewable projects, affecting future revenue streams and potentially increasing costs due to prolonged project timelines.
  
• The fluctuating and higher cost of risk management products, driven by high near-term energy prices and a decline in natural gas availability, may lead to increased financial risk and impact profitability.

Valuation

• The analysts have a consensus price target of NZ$9.829 for Contact Energy based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of NZ$10.76, and the most bearish reporting a price target of just NZ$8.7.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be NZ$2.9 billion, earnings will come to NZ$305.7 million, and it would be trading on a PE ratio of 30.8x, assuming you use a discount rate of 6.3%.
  
• Given the current share price of NZ$9.31, the analyst price target of NZ$9.83 is 5.3% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.