Kaiwera Downs 2 And Nga Tamariki Expansions Will Increase Future Renewable Capacity

Key Takeaways

• Integration and renewable projects are expected to enhance operational efficiency and drive future revenue growth for Mercury NZ.
  
• Investments in technology and infrastructure aim for long-term production capacity and stable earnings.
  
• Mercury NZ faces earnings and margin pressures due to reduced hydro capacity, increased gas costs, geothermal project risks, and regulatory challenges.

Catalysts

Engages in the production, trading, and sale of electricity and related activities in New Zealand.

• The integration of Mercury and Trustpower businesses under a unified brand and system is expected to create operational efficiencies and a solid platform for future growth, positively impacting net margins and earnings.
  
• The construction of the Kaiwera Downs 2 and Nga Tamariki geothermal expansion projects, which are under budget and expected to enhance generation capacity, could drive future revenue growth as these projects come online.
  
• The strategic focus on executing new generation opportunities, including a grid-scale battery and a new wind farm, aims to bolster Mercury's renewable energy supply, potentially leading to increased revenue and earnings.
  
• Enhancements in hydro asset management and the commissioning of upgrades could improve energy production efficiency, potentially increasing net margins.
  
• Investments in technology and infrastructure, such as drilling new wells and modernizing existing assets, aim to sustain long-term production capacity and operational efficiency, supporting future earnings stability.

Mercury NZ Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercury NZ's revenue will decrease by 1.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 8.5% today to 10.7% in 3 years time.
• Analysts expect earnings to reach NZ$348.8 million (and earnings per share of NZ$0.25) by about February 2028, up from NZ$290.0 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting NZ$389.2 million in earnings, and the most bearish expecting NZ$283 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 32.2x on those 2028 earnings, up from 30.7x today. This future PE is greater than the current PE for the AU Electric Utilities industry at 30.7x.
• Analysts expect the number of shares outstanding to grow by 0.2% per year for 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.

Mercury NZ Future Earnings Per Share Growth

Risks

• The company's guidance for FY '25 is set at $820 million, down from a record EBITDAF result of $877 million in FY '24, indicating potential challenges in maintaining past earnings levels due to reduced hydro capacity and increased gas costs. This downturn could impact future earnings and margins.
  
• Mercury NZ is experiencing a dry period with hydro generation forecasted to decrease, which could affect revenue as hydro is a significant part of its energy generation mix. Lower hydro generation impacts the company's ability to sell electricity and maintain trading margins.
  
• The company faces risks in its geothermal projects, such as ongoing drilling challenges and changes in drilling contractors, which could lead to cost overruns or delays, reducing projected net earnings from geothermal operations.
  
• Heightened electricity futures prices and tightness in thermal fuel supply suggest increased operational costs and potential market volatility, posing risks to net margins if the company cannot fully offset these through pricing strategies.
  
• Mercury NZ faces regulatory and market structure challenges, such as potential pricing and market interventions by authorities that could affect trading conditions, impacting revenue stability and long-term profitability.

Valuation

• The analysts have a consensus price target of NZ$6.633 for Mercury NZ 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$7.62, and the most bearish reporting a price target of just NZ$5.6.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be NZ$3.3 billion, earnings will come to NZ$348.8 million, and it would be trading on a PE ratio of 32.2x, assuming you use a discount rate of 6.3%.
  
• Given the current share price of NZ$6.36, the analyst price target of NZ$6.63 is 4.2% 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.