Value Downunder Profile picture
Jul 13, 2021 26 tweets 9 min read Read on X
Utilities are a great defensive stock in times of uncertainty. And with the renewable revolution underway, electric utilities have a multi-decade long tailwind.

But, Australian utilities have been a value trap. Is there an alternative?

Let’s take a deep dive 👇 Image
1. Investment Thesis: Investing in utility stalwarts that are stable during times of recession or equity bubbles.

Not very sexy, but can one get +10% IRR and anchor your portfolio allowing others to do the heavy lifting?

h/t @Alpaca_Capital for suggesting this post Image
2. Let’s define what we mean by utilities. Generally, they are 1) electricity & sometimes gas, 2) telecommunications, or 3) water and sewage.

Today we’re going to focus on #1: electric utilities that may have gas. Image
3. Utilities can also be regulated or unregulated. Regulated have rates set by the government, which differs by jurisdiction, and reflects them being a natural monopoly.

Magellan have a good primer on this:
magellangroup.com.au/insights/an-in…
4. Utilities may also have non-utility like components.

For example, service stream undertake maintenance which is more like a cyclical; whereas others may do infrastructure development (e.g. Tilt Renewables $TLT) which can turbocharge earnings growth.
5. Finally, utilities operate across generation, networks, distribution and retail. Gentailers are vertically integrated.

We’re focusing more on the generation and networks as this is where the specific tailwind exists for renewables over the next 10, 20 or even 30 years. Image
6. Megatrend: There are two key parts.

First, demand is projected to massively increase as we continue to electrify our fleet of vehicles, population grows, median income grows, etc. Image
7. Megatrend: Second, substitution away from fossil fuels to renewable electricity is only getting started. We have recently passed the inflection point of renewables being cheaper than fossil fuels. This is not dependent on taxes or subsides, this is pure economics. Image
8. Huge runway of CAPEX for renewables: The reality is our generators and networks (poles and wires) need upgrading. They’re outdated and inefficient.

And this means there are decades of investing opportunities for electric utilities – unlike most water utilities for example. Image
9. So that’s the set up.

We have a megatrend of renewables, and are looking at the generation / networks as a way to play it because they’re oligopolies, and we can ignore disruption to a specific tech.

So, what does the return profile look like, and where can we invest?
10. @Cultivatewealth has done all the hard work for us on calculating utility revenue requirements:
=(Rate base * ROE) + operating expenses + depreciation + taxes
enlightenedcapital.substack.com/p/utilities-pr…
11. The major difference between Aus, US and even EU is the ‘ROE’ set by Gov.

Across the US it’s around ~9.5-10.5% with higher CAPEX; in Aus we have higher WACC and lower ROE’s, around ~8.5% gross returns on lower CAPEX; Europeans invest more in emerging markets. Image
12. Example of Spark Infrastructure $SKI $SKI.AX – They’re most recent 5yr regulatory determination in Victoria is 8.5% based on 4.73% WACC, leading to lower forecast revenues and margins for their network infrastructure for the foreseeable future. Image
13. Example of Origin $ORG $ORG.AX – While it’s a vertically integrated gentailer with significant gas, the low and declining ROCE demonstrates part of the point… Image
14. … the other part being lower CAPEX ($0.5bn p/a on MC of $8bn, 6% p/a) while management extracts the FCF to afford the dividend rather than investing for the future. It's shareholder cannibalism. Image
15. Example of Dominion $D – Not only do they have higher ROE in the US, sponsored by higher rate cases in the state legislatures… Image
16 … but they also have significant growth CAPEX planned ($32bn over 5yrs on $60bn MC, 11% p/a) resulting in forecast ~10% Total Shareholder Return. Image
17. Example of Iberdrola $IBE.MC – They have massive CAPEX across their global operations, including in Latin America where they can get +12% ROE and are active in M&A including Infigen off the #ASX Image
18. Total shareholder return in the longrun is a function of Dividend Yield + EPS Growth, and EPS Growth is a function of ROE and WACC.

From the table below, you can see the problem with regulated utilities in Australia. Image
19. Catching a falling knife: I personally won’t invest in declining business because I reckon you can never get a margin of safety big enough, and there’s plenty of value traps.
reddit.com/r/ausstocks/co…
20. DeLorean $DEL $DEL.AX: Special shout out for a new renewable bioenergy company that IPO’d in 2021. Assuming they can manage their capital allocation and not dilute shareholders, plenty of potential returns here:
21. Absoloute Returns of 10%: With relatively low risk, you can get 9-10% in the US and potentially higher in Europe.

Three things to keep in mind.

First, exchange rates. A smarter person would add FX risk by looking at rate differentials (AUDUSD ~1.5%).
22. Second, Dividend vs Growth: The US is such a deep market you can have 2% DPS + 8% EPS Growth, or 3/7, or even 4/6. It’s a very efficient market across the 9-10% TSR range.

I like having a range in my portfolio, noting they're ~100% correlated bets.
23. Rates, Bro? Risk of increasing rates is real.

This increases WACC; inflation reduces real revenue; and compresses the PE. If rates increase slowly, the impact is less than people think. Image
24. Overall, this is one way to anchor a portfolio. It may not be sexy, but at least you’ll sleep well.

If you enjoyed this, bash the like / retweet / follow buttons.

Questions and feedback always welcome. DYOR.

Disclaimer, I’m long BEP, D, NEE, DEL.
Well, turns out the least-bad option for electric utilities in Australia (Spark Infrastructure $SKI.AX $SKI) is about to cop a takeover bid.

.. The global hunt for infrastructure and fixed income asset continues to drive down yields, drive up prices, and drive up risk taking.

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More from @DownunderValue

Sep 30, 2022
The global salmon industry is in turmoil as fears of contagion of the Norwegian resource tax hits the Faroe Islands.🐟

P/F Bakkafrost $BAKKA is down another 12% overnight, while the big Norwegians $MOWI $SALM $LSG continue to slide.

Let's take a look at the Faroe Islands 🧵👇 Image
1. Yesterday I looked at Norway's resource tax and figured it was too difficult to find a good risk/reward bet. Right now the best forecasters of European monetary and fiscal policy seem to be a random number generator. Today I'm looking at Faroe Islands.
2. Investment Thesis for $BAKKA:
🐟Quality at a reasonable price
🐟Tax policy uncertainty
🐟Growing volume
🐟Cost competitive
🐟Scottish efficiencies
🐟CAPEX cycle
Read 24 tweets
Sep 29, 2022
Norwegian salmon stocks have collapsed overnight, with the Government threatening a 40% super-resource tax.

$SALM.OL Salmar -30%
$LRY.OL Lerøy -28%
$GSF.OL Grieg -26%
$MOWI.OL -19%

This would destroy the industry. Maybe.

Time to take a look 👇
thefishsite.com/articles/norwa….
Norway produces over 50% of the world's Atlantic salmon. So this is kind of a big deal. Image
Unsurprisingly, the largest salmon companies in the world are also in Norway. In fact, the four largest are from Norway. This is because they have a huge cost advantage in the cold fjords which provide better growing conditions. Image
Read 23 tweets
Aug 31, 2022
Delorean's $DEL $DEL.AX update to the market has left a fair bit to be desired. Engineering division has been decimated, financing remains out of reach, though retail is doing alright. Time to hit the panic button? 🚨

Let's take a closer look 🤏🧵👇 Image
If you don't know what Delorean is, please don't @ me, just look at the original deep dive.
There's no sugar coating the results. Huge loss of $10m NPAT.

But you wouldn't notice if you read the investor presentation, because they just simply don't report it 🤷 Image
Read 19 tweets
Aug 31, 2022
Clean Seas $CSS $CSS.AX FY22 results look really good. I recently spoke with Rob Gratton (CEO) and got to understand more of their business model and strategic direction.

Here's a short thread on my thoughts and why I don't hold 🤏🧵👇
The FY22 results look very strong. Volume growth (3.7kt), ~20% increase in pricing, ~37% revenue increase, 19% reduction in production costs, etc. And for the first time, profitable! 🎯
But I have mentioned before, this is really a bull-whip effect from the diabolical FY20 which saw inventory build up etc, and now being sold in FY22.
Read 11 tweets
Aug 29, 2022
Lark Distilling Co. $LRK $LRK.AX FY22 results have come at the top end of guidance.

Asset base is growing rapidly, revenues increasing, though sales expenses are ramping up too. Meanwhile, no news on the search for a CEO.

Let's take a look🧵👇
But before we jump in, if you want to see the original deep dive you can find it on my pinned tweet along with all the others.

Or here 👇
And you can find all company updates and commentary in reverse chronological order here👇

Read 16 tweets
Aug 18, 2022
Treasury Wine Estates $TWE $TWE.AX FY22 results came out, and they're good considering the China wine-ban is still being flushed out. Total revenues down, but margins and NPAT are both up 🍷😋

Let's take a quick look 👇
You can find my original thread here where I outlined TWE as an asset play, with the hope that profits may return in due course.

To put in perspective the FY22 results, you can see here the 1H22 results were less negative than the market expected. But 2H22 has been pretty strong, which is why NPAT is up *only* 4% but almost 10% if you annualise 2H22.

Read 14 tweets

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