Spark Infrastructure: Interim result 2014

At this rate, Spark Infrastructure would do well to give up on electricity distribution and go into the investing business. The company's underlying earnings increased 15% to $140m for the six months to 30 June, though this was entirely due to the increasing value of financial instruments.

A few months ago Spark purchased derivative contracts that entitle it to a 14% stake in DUET Group, which owns various gas and electricity distribution assets (see Spark buys stake in DUET from 20 May 14 (Hold – $1.88)).

Though Spark has said it doesn't intend to make a takeover bid, DUET's share price increased some 13% following the announcement. This caused an unrealised gain of $23m on Spark's derivatives which more than offset a 3% decline in Spark's share of profits from SA Power Networks and Victoria Power Networks to $152m for the half-year.

Despite regulated price increases of around 10%, on a wholly owned basis the revenue at Spark's networks increased just 1% to $1,139m compared to the previous corresponding period, while earnings before interest, tax, depreciation and amortisation (EBITDA) increased 2% to $718m.

Total revenues at the South Australian network increased 2% to $520m while EBITDA was flat at $360m. Regulated revenue notched up 5% due price increases; however, this was offset by a 14% decline in unregulated revenue which includes asset rentals and services provided to competitor networks.

Revenues for the Victorian network increased a paltry 1% to $547m while EBITDA was up 4% to $358m. The 10% increase in regulated prices only just offset a 25% decline in unregulated revenue and lower electricity use.

Volumes at SA Power and Victoria Power fell 3% and 5% respectively due to the increasing use of solar power. Nearly one in four South Australian houses now have rooftop solar, among the highest penetration rates in the world.

Growing pains

The underlying regulated asset base (RAB) increased 3% to $8.9bn before debt, of which Spark owns a 49% share.

All Australian power networks are facing fewer opportunities to grow their regulated asset bases due to a crackdown on 'gold plating' and solar power reducing peak demand – the few times in a year that contribute almost all of a network's profit (see Electricity disrupted – Part 1 and Part 2).

The Australian Energy Regulator (AER) has also changed various guidelines for how it calculates what networks should earn over a five-year regulatory period, and these will make it harder for Spark to increase profits and distributions following the next regulatory reset which occurs on 1 Jul 15 (see Storm brews for Spark Infrastructure on 24 Sep 13 (Hold – $1.60)).

Spark has continued to deleverage at the asset and corporate level which is encouraging, with net debt to RAB decreasing from 79% to 78%. Management is targeting 75% in 2015.

Spark's share price is flat since Electricity disrupted – Part 2 from 31 Jul 14 (Sell – $1.90). The board declared an unfranked interim distribution of 5.75 cents (ex date 1 Sep), and reaffirmed its expectation for a full-year total of 11.5 cents, up 5% over the previous year, for a forecast yield of 5.9%.

Despite the healthy yield, an enterprise value 1.4 times the regulated asset base is on the expensive side, especially given the regulatory risks and declining electricity volumes. We're sticking with SELL.