Meridian Energy

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

A New Zealand-based renewable energy company, primarily generating electricity from hydropower, wind and geothermal, with a focus on sustainability and a long-term vision.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Meridian Energy (MEJHY) is not just a utility company; it positions itself as a key player in the global transition to a low-carbon economy. They emphasize their commitment to renewable energy production and sustainable practices.

Business Overview

  • Revenue Distribution:
    • Meridian generates revenue primarily through the sale of electricity to both residential and commercial customers in New Zealand and Australia.
    • A key differentiator of Meridian’s revenue is that it relies almost entirely on renewable sources, like hydro, wind and geothermal.
    • The company also has a growing portfolio of energy generation through solar farms.
  • Industry Trends:
    • The global energy sector is undergoing a significant shift towards renewable energy sources, driven by concerns about climate change and government mandates.
    • There’s an increasing push for decarbonization and electrification worldwide, which significantly increases the demand for clean energy and helps shift the supply away from fossil fuels.
    • Government policies, subsidies, and tax incentives are becoming more favorable for renewable projects.
    • The technology for renewable power generation is improving rapidly, leading to a decrease in costs and increase in efficiency.
  • Margins:
    • Meridian has relatively healthy gross margins which have averaged around the 40-45% mark in the last 3 years.
    • Net margins are much more volatile because of non-recurring expenses and fluctuations in fair value of derivatives.
    • The company has a history of maintaining consistent operating margins.
  • Competitive Landscape:
    • The renewable energy sector is becoming increasingly competitive. New players are emerging, while larger and established utilities are increasing their focus on renewables.
    • In New Zealand, the industry is dominated by a few key players, with state-owned entities also playing an important role in the industry.
    • In Australia, the renewable energy market is also fiercely competitive, especially with increasing penetration of wind and solar projects.
    • The market has also seen a surge of solar and battery installation at the customer-side (behind-the-meter), which poses further competitive pressure.
  • What Makes Meridian Different?:
    • Meridian stands out because it’s a pure-play renewable energy provider, focusing almost entirely on hydro, wind, and geothermal. This contrasts with other utilities that also have coal, gas, or nuclear assets in their portfolio.
    • The company’s geographic concentration in New Zealand gives them an advantage given that the country has extremely high renewable energy potential.
    • They are also vertically integrated meaning they generate and retail electricity, giving them more control of prices, operations, and customer acquisition, in a relatively non-competitive area.
    • Their efforts to invest in other renewable sources like solar and battery storage also create more sustainable cash flows in the future.
  • Risks to Moat and Business Resilience:
    • Resource availability: The primary risk comes in the form of changes in the environment, as the majority of their production depends on weather (more specifically water inflow to their reservoirs).
      • In the most recent fiscal year, lower levels of water inflow resulted in poor hydroelectric generation, causing financial losses for the company. This event highlights the potential volatility caused by a reliance on weather as the main driver of energy production, despite their diversification with wind and geothermal plants.
    • Regulation: As government regulations change, the requirements to sell and price electricity could potentially harm future cash flows and their overall profits. Specifically in New Zealand, where there is higher regulatory intervention, prices may be forced down and profits may be squeezed.
    • Technological disruption: Although the company’s existing business is heavily dependent on old technologies, there is also the constant threat of technological disruption that could make its infrastructure irrelevant.
    • Major Competitor Acquisition: With the recent acquisition of a large local competitor, they have taken on an additional 400 million dollars in debt. While the management believes it’s a good move for long-term growth, this increase in debt does increase risk to solvency for the company.
    • Price sensitivity: Pricing can be a key point in the competition, as large customers can make use of their size to bargain with the company on pricing.

Financials

  • Revenues: In the most recent report, Meridian saw a decrease in revenues. The group’s total revenue was at 3.6 billion dollars, 12.2% lower year-on-year. The reason behind the fall in revenue was the lower hydro-generation numbers caused by a drought, which pushed down sales volumes significantly.
  • Profitability: The operating earnings (EBITDA) were affected strongly by low hydro-generation, and were at 955 million for the year, 22.7% lower than last year. Net earnings also decreased to 425 million, 39% lower year-on-year. Earnings per share also fell to 17.64 cents from 29.07 cents the year prior. The average operating margin is 26.5%.
  • Invested Capital and Free Cash Flow: Although the revenue and earnings are very volatile, the company can still generate considerable cash through its operations. This is reflected in their relatively high free cash flow numbers, however this value still declined from 946 million the prior year to 754 million this year. The company has stated that ROIC for 2024 came to 8.8%, while ROE came to 11.8%
  • Capital Structure:
    • The company has approximately 4.9 billion dollars in debt on the balance sheet and approximately 2.7 billion dollars of equity. This is largely due to a massive acquisition in 2023, where the company took on an extra 400 million dollars of debt to buy one of their major competitors.
    • It has a reasonable debt-to-equity ratio and an EBIT-to-interest ratio above 3.5, suggesting that the company is able to comfortably serve the debt.

The recent acquisition of Contact Energy will likely improve the long-term performance and efficiency of the company. However, it comes with more risk of debt on the balance sheet.

Moat Analysis

  • Moat Rating: 2/5
  • Meridian’s moat is narrow based on unique geographical conditions that result in abundant water resources. It’s not as wide as other companies because competitors can invest in wind and geothermal to reduce that edge, and the reliance on weather introduces some variability in their production which is a source of risk.
  • The company does have some form of switching costs with their existing retail customers, due to the convenience of automatic payments and a local, reliable supplier. But this is easily overcome if a competitor can offer a cheaper deal, and there are many cheaper offers available from smaller providers. * However, overall, I believe it is a narrow moat with a limited long-term competitive advantage.

Understandability

  • Understandability Rating: 3/5
    • The company’s operations are pretty straightforward. They use renewables to produce energy and sell it.
    • They are also heavily regulated which makes it easier to see their finances.
    • The only part that is very difficult to fully grasp is their usage of financial instruments, and derivatives in particular, for hedging and trading. Their balance sheet is often complex with such a large portion of financial derivatives.

Balance Sheet Health

  • Balance Sheet Health Rating: 4/5
    • The company has a moderate level of debt, compared to equity.
    • Even though they took on additional debt, and have seen a downturn in profitability and cash flows, they have been historically profitable and have consistently maintained an acceptable solvency ratio.
    • The debt obligations don’t seem extremely risky to the stability of the company.
    • Their liquidity position is healthy, and therefore their ability to meet obligations in the short-term is assured.

In summary, Meridian Energy is a renewable energy company with a narrow moat, and a healthy but volatile business. Its future growth will likely be shaped by government policies, as well as the success of technological development in the renewable energy sector. Despite some short-term difficulties, the management believes in its long-term strategy.