News Column

VECTOR LTD. - FINANCIAL RESULTS FOR THE YEAR TO 30 JUNE 2014

August 26, 2014



ENP Newswire - 26 August 2014

Release date- 22082014 - New Zealand's leading integrated energy infrastructure company Vector reports earnings for the year to 30 June 2014 in line with market expectations.

The results from the Technology business and notably our smart metering business partially offset the end of our entitlements to Kapuni gas at legacy prices and significant and well-signalled price reductions on our regulated energy networks.

Revenue fell 1.6% to $1,258.9 million from $1,279.2 million, while adjusted EBITDA fell to $580.7 million from $630.5 million. Net profit fell 16.9% to $171.3 million from $206.2 million. The regulated price reductions on our energy networks were responsible for most of the fall.

Vector Chairman Michael Stiassny said: 'Vector has faced a challenging year but we continue to deliver on our goal: to be New Zealand's first choice for delivering integrated energy infrastructure. 'We have met our goal to continue to generate sustainable increases in dividends to our shareholders. The board has declared fully-imputed dividends for the year totalling 15.25 cents per share, up 0.25 cents on the prior year's total dividend.

'This is the eighth consecutive year of increases, reflecting prudent management of our capital in the lead up to regulator-imposed price reductions on our energy networks and our determination to provide investors stability through regulatory periods. It also reflects our success in delivering services attuned to our customers, growing our portfolio of businesses and driving operational excellence.

'However, further recent regulatory actions place additional pressure on future dividends and investment in our regulated assets. 'We are investing in our people and supporting diversity in our business. This year we joined the 25 Percent Group of New Zealand companies, which promotes diversity in board rooms and we celebrated the fact that 25% of our directors are women. We understand diversity is about diverse thinking that provides for better governance and a better bottom line.

'Vector is helping to foster the next generation of directors with the appointment of Tony Arthur to the board as part of the Future Directors scheme. Tony, head of BNZ's retail network, participates fully in board discussions, but does not have formal voting rights. 'Given the concentration of our assets in Auckland, Vector's energy infrastructure business is well positioned to grow over the long term, as long as commercial rationality emerges in the regulation of our energy networks. We also continue to see the emergence of opportunities particularly in our Technology operations.'

Vector Group Chief Executive Simon Mackenzie said: 'Our commitment to understanding and taking into account customers' current and future perspectives is delivering for Vector's shareholders, Auckland and the broader national economy.

'Only a few years ago OnGas Bottle Swap, our smart metering business and Vector Communications made a negligible contribution to the group result. Today they make a significant contribution to our bottom line. Their success demonstrates our ability to generate new revenue streams by leveraging our role as New Zealand's leading integrated energy infrastructure provider.

'We have similar aspirations for a number of emerging businesses within our portfolio of operations. We have this year installed close to 200 of our award-winning SunGenie solar units across Auckland in a trial of this technology and we believe distributed photo-voltaic generation technology is maturing to the point of mass market appeal.'

As at 30 June 2014, Vector had installed 675,555 smart meters. We are contracted to install almost 900,000 smart meters, up from 764,000 a year earlier following new contracts with Contact Energy and the SmartCo consortium of electricity distribution businesses.

New Technology

'We understand the pace of change in our industry will increase exponentially over the next decade and we are prepared. The balance of power is shifting from utility service providers to consumers. Energy distribution technology - largely unchanged for decades now allows customers to switch suppliers, switch energy solutions and switch from the grid.

'Customers are demanding choice and the highest standards of service from utility service providers. They are targeting energy consumption as an area for saving money and they are actively managing their energy needs. They are also environmentally conscious and more technologically savvy and therefore willing to adopt technology such as solar panels that allow them to generate their own electricity.

'These trends are of course challenging. As a direct result, the consumption of energy transported across our network is falling and the pace of this decline will increase in line with the growing affordability of new technology. 'Vector is at the forefront of this evolution. We are working on numerous initiatives around distributed generation, battery storage, smart metering, energy management, electric vehicles and gas smart meter technologies.

'New communications technologies such as our outage manager app, which provides details of outages and the likely time to the restoration of power to smart phones and the Vector website, are meanwhile improving the customer experience. Since inception the outage manager received more than 2.6 million hits and it was used heavily during the recent storms. We are now looking at making this technology available to other network companies around the country.

Regulation and investment

'We are concerned the regulatory regime is not keeping pace with this technological change and global trends. Over the long-term, this could discourage investment in regulated energy networks and put at risk the security of the energy supply.

The regime assumes that new network investment will have an average life of more than 40 years and that the bulk of our positive cash flows should be skewed towards the end of that period as we are preparing for the renewal of those assets. As a result it requires Vector to commit to significant upfront capital expenditure and accept a cash flow profile that does not reflect the risk we are taking.

'Investors will look warily at such a long duration investment proposition, especially in the face of such disruptive technological and social change. Vector faces significant risk that, over a 40 year period, essential assets may become redundant and cash flows deferred under the regulatory regime may not be recovered. We believe a more sensible approach is for the Commerce Commission to allow Vector to generate cash flows that better reflect the useful life of assets. It has allowed other operators in the sector to adopt this very approach.

'Because the regulator's assumptions for asset revaluation rates do not match the actual rates, we are not able to generate the returns determined by the regulator. PwC, for instance, has calculated that differences between recorded inflation and the Commission's forecasts for inflation will result in electricity distribution businesses recovering $150 million less than they are allowed over the 2013-2015 regulatory period. The regulator's model takes no account of this. Over the current regulatory period this has cost Vector $57 million and we are seeking to recover this amount.

'Finally, the Commerce Commission's draft decision in July to adjust the method it uses to determine our cost of capital - and therefore reduce the allowable returns on our assets gives us further cause for disquiet. The decision runs contrary to a position the Commission has held for a considerable period of time and one that has been backed up by a body of analytical work over time.

It is clear the frequency of change to core elements of the regulatory regime is adding significant cost to New Zealand infrastructure providers. International rating agency Standard and Poor's this year downgraded Vector's corporate credit rating by one notch to the 'investment-grade' BBB, from BBB+, due to what it saw as instability and greater risk in the New Zealand regulatory regime.

'Vector operates its regulated networks safely and efficiently. Our electricity distribution network is among the lowest cost in the country on measures such as operating expenditure per unit of electricity delivered and average operating expenditure per connection. 'Auckland continues to grow and with it our regulated asset base. Indeed, in the last year it has driven an increase in connections to our gas and electricity distribution networks from 696,184 to 703,691.

'The Government and Auckland Council are targeting an additional 39,000 houses over the next three years. We welcome and support this aspiration. The pace of development in Auckland has picked up reflecting these initiatives, favourable economic conditions, strong net migration to the region and a gradual recovery in the housing market after several years of sluggish growth in the wake of the global financial crisis.

'We have invested in good faith to support this growth with capital expenditure on our electricity network rising 8.1% or $12.1 million in the 2014 financial year to $162.3 million, while capital expenditure on our gas transmission and distribution networks rose 26.9% or $10.1 million to $47.6 million.

'Nevertheless, the unattractive cash flow profile and the allowable returns on our regulated networks are making it increasingly difficult to advocate for incremental capital to be allocated to our regulated businesses, especially when we see the potential for much more appropriate commercial outcomes in our non-regulated activities. 'We will continue to work with the regulators and government to address the imbalances we see.

Outlook

'The coming financial year will be challenging with regulatory pricing adjustments relating to prior periods and an expected continued decline in per capita electricity usage offsetting the growth in connection rates. However, at this stage we are comfortable with consensus estimates for adjusted EBITDA of $588.2 million for the 2015 financial year, subject to finalisation of regulatory parameters in November 2014, Auckland growth and energy demand.

We have a great team committed to our core goals and we remain focused on customer solutions, the demands of our gas customers, delivering on the potential of our Technology operations and - assuming commercial rationality in the regulation of our energy networks emerges - meeting population growth in Auckland.

Electricity

Weather had a significant impact on the Electricity business in the 2014 financial year. Warmer winter temperatures contributed to an overall 1.0% decline in consumption whilst an unusually high number of extremely windy days contributed to a significant increase in normalised SAIDI2 - our measure of network reliability. This rose to 141.3 minutes for normal operations in the regulatory year to 31 March 2014 from 95.8 in the previous regulatory year, exceeding the Commerce Commission threshold of 127 minutes.

We have devoted significant effort to improving our ability to prepare and respond to storm events. Together with our field service provider partners, we make a huge effort to minimise customer outages. We have also focused on improving communications during outage events, particularly via the Vector outage manager app and we will continue to promote prudent tree management with our customers to assist in the protection of power lines during a storm.

We are starting to see the impacts of Auckland Council's housing initiatives. Net new electricity connections for 2014 were 4,721, up 17.9% on the previous year. Electricity customer numbers increased 0.9% to 543,953.

Despite the increase in connections, power transported across our networks fell to 8,252 GWh from 8,332 GWh. The trends for consumers to use less energy and to continue to look for ways to reduce their consumption as well as the warmer weather were responsible for this decline. Both August 2013 and June 2014 claimed 'warmest on record' status. Heating degree days3 were 1,077 and were 6.3% lower than the 1,150 recorded in the prior year.

Electricity revenue was in line with last year, although this result includes an approximately $14.3 million increase in pass-through charges (primarily due to a 17.2%4 increase in

Transpower transmission charges) and a $6.2 million increase in capital contributions (on the back of higher new connections and significant Auckland infrastructure activity). These other revenue lines broadly offset the decline in consumption and the weighted average total 10% price reduction imposed by the Commerce Commission since April 2013.

EBITDA fell 7.1% to $346.0 million from $372.5 million. The key drivers of this decline were lower consumption, regulated price reductions and higher maintenance costs.

Gas Transportation

The Gas Transportation result for 2014 reflected price reductions set by the Commerce Commission on our gas transmission and distribution networks from 1 October 2013. Prices will increase this year albeit to a level that is still below the October 2013 prices. We had sought to smooth these prices over the two periods, but our approach was rejected by the regulator.

Just as we are seeing in electricity, our gas distribution networks are starting to experience significant connection growth - overall new connections were up 21.0%. Increased gas usage by industrial and commercial customers was a key driver in lifting gas distribution volumes by 2.3% to 21.9 PJ from 21.4 PJ. Gas transmission volumes on the other hand fell by 5.8% to 111.3 PJ from 118.2 PJ, primarily due to lower demand from power stations. Gas transmission revenues however are approximately 90% fixed (relative to capacity reservation) and are therefore largely independent of actual transmission volumes.

Overall, Gas Transportation revenue fell 14.8% to $187.0 million from $219.6 million. An increase in capital contributions; distribution volumes and other revenues (predominantly pass-through costs relating to the operation of the Maui pipeline) contributed $9.7 million, going some way to offset the impact of the October 2013 price cuts.

Gas Transportation EBITDA fell 21.7% to $133.4 million from $170.4 million, as the reduction in revenue flowed through to EBITDA.

Gas Wholesale

The Gas Wholesale result was supported by strong growth in our LPG business. This partially offset a weaker result for gas trading, due to increased competition and the end of our entitlement to Kapuni gas at legacy prices.

LPG volumes were up over the previous year, with strong growth in wholesale and across all cylinder markets. Liquigas LPG tolling volumes increased 17.8% to 178,510 tonnes from 151,544 tonnes. Competitive pressures in the market are intense, but we continue to grow our position.

Natural gas trading volumes fell 7.5% to 24.5 PJ, reflecting lower demand from electricity generators, while industrial and commercial volumes were flat. Production issues at the Kapuni field during the first quarter were largely rectified by the field operator, with average production of 39.0 TJ per day in 2014, back up to over the 2013 levels of 38.8 TJ per day.

Revenue fell 6.0% to $349.8 million from $372.2 million, due largely to lower sales volumes and greater competition among natural gas wholesalers. EBITDA fell 15.7% to $50.9 million from $60.4 million as natural gas trading margins contracted due to the end of our entitlements to Kapuni gas at legacy prices and increased competition for customers.

Vector's rights to approximately 7.3 PJ of Kapuni gas at legacy prices were confirmed by the High Court. The High Court dismissed appeals by the suppliers of Kapuni gas against an arbitral award in Vector's favour. The High Court subsequently dismissed an application for the decision to be further appealed to the Court of Appeal, and made an award of costs to Vector.

Vector retains the right to purchase 50% of the gas remaining in the Kapuni field from 1 April 1997. We are in the process of resolving the price for the next tranche of that gas via arbitration, which is scheduled to commence in April 2015.

Technology

Vector's metering business continued to drive strong growth in our Technology business during 2014. Revenue increased 25.6% to $137.0 million from $109.1 million, reflecting a 33.5% increase in the number of deployed smart meters and the successful integration of the Contact gas metering business acquired at the end of the last financial year. EBITDA increased 31.1% to $100.0 million from $76.3 million.

The focus of the metering business over the 2014 financial year was on delivering on existing contracts and developing an enterprise scale meter data management platform. We installed approximately 170,000 smart meters during the year, an average of over 14,000 meters per month.

We are approximately three quarters of the way through our currently contracted deployment, and we expect to maintain our current rate of deployment over 2015. There are still approximately 845,000 legacy meters remaining across New Zealand, which will most likely be replaced with smart meters over the next three to five years. We expect the upcoming metering certification deadline of 1 April 2015 to drive deployment of smart meters over the next nine months, and we are well positioned to rollout these meters.

Vector Communications continues to grow its footprint as it gets closer to both its reseller and direct customers. Our network now reaches more than 10,000 Auckland business addresses. Enhancements to our product and service capabilities coupled with improved online quoting, reporting, and notification tools, have better equipped us to leverage our own and third party telecommunications infrastructure and provide a higher level of support to our customers.

Total capital expenditure increased 13.6% to $339.2 million from $298.6 million. Capital expenditure directed at growth initiatives was $202.6 million, and was split evenly between the regulated and non-regulated businesses. Capital expenditure focused on maintaining the quality of our assets was $136.6 million, with almost 80% of this spend focused on the regulated networks.

On the electricity network capital expenditure was up $12.1 million, driven by increased connections and significant reinforcement expenditure in rapidly growing areas such as Flatbush, East Auckland. Gas Transportation capital expenditure rose from $37.5 million to $47.6 million. This reflected growth in residential customer connections in line with the growth in Auckland, as well as new industrial and commercial connections, notably the new connection to Yashili New Zealand Dairy's new factory in Pokeno.

In the Technology business capital expenditure of $105.0 million, up from $88.9 million in the previous year, was primarily targeted at funding the meter rollout and IT investment programme.

Capital Structure

Vector maintains a sound balance sheet. We have a well-diversified debt portfolio with a weighted average duration of 5.0 years as at 30 June 2014. We have recently refinanced our senior bonds, which mature in October 2014, with an equivalently sized issue into the US private placement market.

Our gearing, as measured by net debt to net debt plus equity, rose to 51.6% as at 30 June 2014 from 51.1% at the beginning of the year. Our 2014 interest cover is 2.3 times compared with 2.8 times for the year ended 30 June 2013.

Standard & Poor's rating action will not have any immediate financial impact on our business given the long dated duration of our debt portfolio. We remain an 'investment grade' credit risk, with a BBB/stable rating from Standard & Poor's and a rating of Baa1/stable from Moody's.

Investor Contact:

Dan Molloy

Chief Financial Officer

Tel: +64 9 213 5179

Mob: +64 21 441 311

Media Contact:

Sandy Hodge

Manager

Tel: +64 9 978 7638

Mob: +64 21 579 522

About Vector

Vector is New Zealand's leading multi-network infrastructure company which delivers energy and communication services to more than 700,000 homes and businesses across the country. The company owns and manages a unique portfolio of businesses, which consists of electricity distribution, gas transmission and distribution, electricity and gas metering installations and data management services, natural gas and LPG and fibre optic networks.

Vector is listed on the New Zealand Stock Exchange with ticker symbol VCT. Our majority shareholder, with a 75.1% stake, is the Auckland Energy Consumer Trust (AECT).


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Source: ENP Newswire


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