The Smart Money

Buyer Beware

We have been approached by several folk wondering about the investment wisdom of buying some of the state owned electricity companies when they come on the block.  On the surface of it, power companies usually provide stable income flows, a good dividend stream, and solid earnings growth.  The stuff blue chips are made of.

But--there is always a but--let's not neglect the big-picture, or helicopter view.
  The government will remain the majority shareholder in all cases.  That means the government of the day will ultimately control and direct the businesses.  Now, it is true these companies are run on an arm's length basis.  But the government for the next decade will be starved for revenue.  The temptation to run these companies as cash cows for the government's coffers will be intense.  Politicians are known for persistently favouring short term gain and long term pain (when someone else will have to deal with the problem), whilst keeping their eye firmly on the next election.

Some will spring to the defence of government.  They will point out how both Labour and National administrations have maintained majority shareholdings in "our national" airline, Air New Zealand.  Yet through a very difficult time for the aviation industry the government has have kept itself at arms length, allowing the company to chart its own commercial destiny.  Surely that will equally apply to Mighty River Power and Genesis Energy etc.

Maybe.  But consider this.  Would the owner of Air NZ have kept its "hand's off" stance if Air New Zealand had delivered financial results like Qantas has recently?  What if Air NZ needed an injection of capital because its losses had been so severe?  What then?  

Moreover, the energy industry is now highly politicised.  It was not always the case, but with global warming mania it now most certainly is operating in a highly politicised sector, where government is taking upon itself the task of changing commercial behaviour for the "good" of mankind.  Our state owned power companies are in the front line of that Canutian struggle.

As a rule of thumb, any electricity company which is touting investment in "clean, green energy" where the economics simply don't stack up should be avoided like the plague.  Such companies can be expected to bleed into deepening pools of inefficiency and low margins.  "Doing the right thing for mankind" might make the management and directors and the government-of-the-day feel morally self-righteous, but shareholders are going to pay for their master's scruples.

Geothermal is OK.  Hydro is fine.  Nuclear, the sooner the better.  But wind farms?  Economic lunacy and moralistic myopia.  Expect huge write downs for years to come, once the capital investment has been made.  Bottom line earnings are going to be pretty thin for such companies and certainly volatile.  And guess where most new investment in generation in New Zealand is occurring.  You guessed it. 

Finally, would you invest in an industry which is effectively price controlled?  And the controls are ultimately reflective of populist outrage over rising power prices which shows up at the polling booth.  Normally, this might not be such a big issue, but when government indirectly, but ultimately, controls the prices charged to consumers, and is the majority shareholder in our generation companies, and has eyes always on the next election which is always so close in the New Zealand electoral system be warned.  The risks are enormous. 

Just remember, government can tolerate low, sub-par financial performance of its businesses far longer than private investors.

Our conclusion--by all means look at the offer documents, but be aware of the big picture and the intrinsic riskiness of power companies in New Zealand.  Don't be fooled by the "safe, solid, blue chip" image of yesteryear--which will "frame" the offer documents.  We expect that a bunch of NZ financial institutions, Maori financial interests, and KiwiSaver funds will buy up big--in fevered haste.  They will have plenty of time to repent, in their leisure.

Sam Stubbs of Tower Investments has boldly stated that his company would be selling up overseas investments in order to purchase NZ power companies.  That implies Tower must have some pretty sub-par international assets already in its portfolios.  Commercial advantage and shareholder return is the only justifiable reason for quitting international investments in favour of NZ power companies, right Sam?  Not company image.  Not PR.  Not national pride.  Please, tell us none of these things will be influencing your investment decisions.  Pity your investors if they do.