Power networks were among the safest forms of infrastructure investment during the coronavirus sell-off and remain so during the impending recession, say Morningstar analysts.

Within the normally highly defensive category, near-term revenue is most at risk among infrastructure companies exposed to travel, including Sydney Airport (ASX:SYD) and Auckland International Airport (ASX: AIA).

“Best placed are regulated gas and electricity networks Spark Infrastructure (ASX: SKI) and AusNet Services (ASX: AST), where downside should be limited to a small amount of rate relief for hardship customers and some payment delays,” say Morningstar senior equity analyst Adrian Atkins and Adam Fleck, director of equity research for Australia and New Zealand.

Spark Infrastructure

Morningstar Rating: 4-star | Economic Moat: None | Price-to-Fair Value: 0.88

Spark is an electricity distribution company, owning 49 per cent of three networks: CitiPower and Powercor in Victoria—known collectively as Victoria Power Networks (VPN)—and SA Power Networks (SAPN) in South Australia. The company also owns 15 per cent of electricity transmission network TransGrid.

At the market close on Tuesday, Spark's share price of $2.12 was trading 15 per cent below the fair value estimate of $2.40.

AusNet Services

Morningstar Rating: 3-star | Economic Moat: None | Price-to-Fair Value: 1.03

AusNet owns three electricity and gas networks in Victoria—two electricity grid networks and a gas distribution network.

Its stock was priced at a level Morningstar considers fairly valued at Tuesday's market close, shares trading at $1.76 versus a fair value estimate of $1.70. 

The two companies share similar characteristics in that they are both regulated utilities, their allowable margins set by government entity the Australian Energy Market Operator (AEMO).

As such, their earnings remain largely insulated, despite the voluntary fee rebates extended to some consumers via their power retailer customers during the worst of the pandemic.
Bad debts don’t pose much of a risk either, because the network owners are paid by the retailers, say Atkins and Fleck in a recent special report.

“Any failure of a small retailer should see affected customers shifted to a large retailer,” say Atkins and Fleck.

Spark and AusNet were also shielded from the worst of the manufacturing shutdowns implemented in response to the coronavirus pandemic. This is because neither of them has large numbers of industrial customers, seeing electricity demand fall only a few per cent during the crisis—and this was partly offset by higher residential usage.

Regulatory resets

"Every five years there's a regulatory reset—but that's a 'known known'. We know they are going to get lower revenue over the next two or three years, but that's nothing to do with coronavirus," Atkins says.

Spark's profits are next due to be reviewed by AEMO in the middle of 2021.

"SAPN is the first to suffer new, lower regulated returns from mid-2020, followed by VPN in January 2021. TransGrid's returns are locked in for another 3.5 years," he says.

Atkins expects weaker dividend growth for a few years from 2021 but is more upbeat over the longer term as bond yields improve.

This is important because the government tariff adjustments are linked directly to the 10-year bond yield, which hit record lows in mid-2019.

Healthy balance sheets

Neither Spark nor AusNet disclose much detail on their debt covenants—which are limits for certain credit metrics that banks set for companies before extending loans to them. But both management teams have confirmed their headroom is substantial. “We don’t see any reason to doubt them,” say Atkins and Fleck.

Exhibit 1: Interest cover, in particular, is forecast to remain reasonable for AusNet and Spark

Exhibit 1: Interest cover, in particular, is forecast to remain reasonable for AusNet and Spark

Source: Morningstar Estimates. Data as of 01/06/2020

They don’t consider Spark’s debt covenants to be at risk because gearing isn’t expected increase substantially.

“We believe Spark's underlying network companies have earnings-based covenants, but because earnings shouldn't fall materially, a breach is unlikely,” say Atkins and Fleck.

In the case of AusNet, the firm is in good financial health, with a solid balance sheet and two strong large shareholders in Singapore Power and State Grid of China, who are likely to offer financial support if conditions deteriorate.

Morningstar also sees little need for capital raising from either company to cope with the “expected minor hit” from COVID-19.

But Atkins and Fleck say both firms may raise equity to help fund developments, “particularly in electricity transmission where the scope of work needed to accommodate growth in renewables is huge.”

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