We recently reviewed AusNet Services (ASX:AST) after the Company reported its results for the 12 months to 31 March 2020 (FY20). With the shares recovering off lower levels, the key issues worth examining are: i) The extent to which distribution growth can recommence after the Company downgraded distribution guidance for FY21; ii) Whether the balance sheet can fund CAPEX requirements without the need for an equity raising and iii) The change in the regulatory risk profile.
About AusNet Services
AST is an energy network business, with electricity distribution and transmission and gas distribution networks located in Victoria. Over 95% of AST’s earnings are generated from energy networks regulated by the Australian Energy Regulator (AER), with regulatory cycles running for five years.
The remainder of earnings is generated by its Mondo energy services business, which is an unregulated business that provides contracted infrastructure asset services and technology solutions to 3rd parties.
Key Fundamental Drivers
Can Distribution Growth Re-Commence?
The Company reported a solid result FY20 result, which saw underlying Net Profit After Tax (NPAT) of $291m come in ahead of consensus estimates by ~10%. This was due to higher customer-initiated contributions in electricity transmission. Despite the better-than-expected result, the market’s focus is more squarely on AST’s DPS guidance of 9.0-9.5 cents per share (cps) for FY21. This compares to 10.2cps in FY20 and was below consensus estimates at the time of the FY20 results release of 10.4 cps. Distributions are expected to be ~40% franked. There are several key factors leading to the lower-than-expected DPS guidance:
i. High CAPEX requirements,
ii. AST is taking a conservative approach to capital management in the current market volatility, with the current balance sheet position unlikely to support distribution growth and material growth CAPEX.
iii. Entering lower regulatory revenue cycles from FY22, with 25% of revenues for the FY21 Electricity Distribution business exposed to the new Rate of return Guideline, and
iv. Uncertainty relating to the impact of COVID-19 customer hardship programs.
Despite the lower-than-expected distribution guidance, there are avenues for the Company to maintain and/or grow distributions from FY21 onwards remain. These include moderating growth in operating costs, growth in unregulated revenues (i.e. from the Mondo business), a staggered regulatory reset profile and headroom in debt/credit rating metrics.
Sufficient Balance Sheet Liquidity, But an Equity Raising May Still Be Needed
With AusNet generating ~$700m per annum of operating cashflow and ~$1.5b in liquidity, AST sufficient capital to fund CAPEX requirements over the next 3-4 years. The Company is investing in CAPEX in order to achieve its targets: i) Regulated Asset Base growth of ~2.5% p.a. to FY24 (moderating from ~3% to FY22 previously) and ii) Contracted Asset Base (CAB, or ‘unregulated assets’) growth of ~21% p.a. to $1.5b by FY24 (unchanged).
Despite strong levels of liquidity and cashflow, an equity raising may still be needed. In order for the Company to maintain its credit rating, the ratio of Funds From Operations (FFO)/net debt needs to be a minimum of 9.5%. At present, AST’s ratio is very close to the minimum requirement and the Company may struggle to maintain FFO/Net debt above 9.5% in FY22/23, especially as CAPEX for the unregulated business increases with the main construction phase of the Western VIC Transmission Upgrade Project.
An equity raising has the potential to provide AST with sufficient headroom to fund its CAPEX requirements, support DPS growth over FY22-24 and maintain FFO/Net debt above 9.5%.
An alternative way for AST to fund CAPEX and keep distribution growth flat is to refinance maturities with new debt and raise equity at the same time in order to ensure FFO/Net Debt is above the threshold. This combined approach would also be less dilutive than an equity raising alone.
The key upside risk to group earnings is potentially higher growth from its unregulated assets. However, we take a cautious view on AST’s fundamentals. Aside from credit metrics remaining under pressure until capital is raised, AST’s key investment attraction of yield being impacted by the downgrade to distribution guidance.
Further, valuation metrics are starting to look stretched. A key valuation metric for AST is the Enterprise Value (EV) to Regulated & Contracted Asset Base ratio, which is currently ~1.6x and well above the upper end of the range since December 2015. In addition, the EV/EBITDA multiple, at ~13x is well above both recent levels and the 5-year average of <12.0x.
It looks like the low from early July should hold and AST should continue to creep higher from here. However, it is likely to hit some resistance around $1.90. Therefore from a charting point of view, there isn’t much upside from here until the share price may start to consolidate again.
Michael Gable is managing director of Fairmont Equities.
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