Many companies reported their full-year results during the period, providing a welcome opportunity to refocus on individual company fundamentals, which we believe are the most important driver of long-term returns. Overall, we felt that results were relatively robust. Of course, higher interest rates appear likely to dampen economic growth and future earnings, which may be felt more acutely by cyclical businesses, which we are typically underweight. We also note some signs of corporate interest in high-quality technology companies which have been out of favour in recent months. One beneficiary during the period was our holding in Nitro software, which received a takeover proposal at around a 40% premium which was subsequently rejected by the Board of the company.

Despite the market’s ongoing focus on macroeconomic trends – we remain focused on bottom-up research and patiently allocating capital to opportunities that meet our Ethical Charter and offer the prospect of sustainable long-term returns.

New Zealand companies account for ~12% of the Fund and offer some attractive investment opportunities in our core sectors of Technology, Healthcare, and Renewables.

NZ Trip and Contact Energy

During the quarter one of our senior analysts paid a visit to New Zealand, where our Australian Shares Fund (the ‘Fund’) holds several local companies. New Zealand companies account for ~12% of the Fund and offer some attractive investment opportunities in our core sectors of Technology, Healthcare, and Renewables. The trip focused on infrastructure and renewables, starting with Meridian Energy in windy Wellington, followed by a road trip to Taupo to visit Contact Energy’s Tauhara geothermal project currently under construction, and finally to the opening of Napier Port’s new wharf (Wharf 6), which was built using funds raised from their IPO in 2019. As investors in the Napier Port IPO, it was rewarding to see the impact the investment has had on the footprint of the port and the subsequent growth in the business it will facilitate.

Contact Energy (CEN-NZ) is one of our key New Zealand investments and is held in a number of our portfolios. With a NZ$6bn market cap, it is a significant stock in the NZ market, but is relatively under-owned by Australian fund managers who tend to focus on utilities in the Australian market. CEN operates a similar ‘Gen-tailer’ business model to the likes of AGL and Origin, generating electricity and selling it to a retail customer base across New Zealand. However, unlike AGL and Origin, CEN generates most of its electricity (~85%) from renewable energy sources – primarily hydropower and geothermal. The remainder of CEN’s generation comes from gas, which is used to firm CEN’s renewable generation. However, with additional renewable projects under development (such as the 168MW Tauhara geothermal project), CEN’s gas generation will be reduced further in coming years with renewable generation moving closer to 100%.

We spent time with CEN’s management team and visited the Tauhara geothermal project under development near Taupo. The $818m project will add 168MW and 1.4TWh to NZ’s electricity network when complete in late 2023 - equivalent to a 3% increase to the grid. Tauhara is the most significant geothermal development available in New Zealand and, as a baseload renewable energy source, will enable a reduction in thermal generation sources, including CEN’s own TCC gas generation plant, which will be retired in 2024.

Tauhara is the most significant geothermal development available in New Zealand and, as a baseload renewable energy source, will enable a reduction in thermal generation sources.

Aside from its renewable credentials, we view CEN as an attractive investment for a number of reasons. Firstly, we believe the long-term market dynamics for CEN and the other New Zealand ‘Gen-tailers’ is positive, with the local Government intently focused on decarbonising the economy. As a result, market forecasts expect that the current annual electricity generation of 43TWh will increase to 60-80TWh over the coming decades - an increase of ~50-100%. This provides opportunities for CEN (and the other New Zealand ‘Gen-tailers’) to develop additional renewable generation projects that will add to earnings and dividends over time. Whilst there has been concern recently around the potential closure of Rio’s aluminium smelter at Tiwai (which accounts for ~13% of New Zealand’s electricity demand), all indications now suggest Rio is likely to commit to continuing to operate of the site over the longer term. With other electricity demand initiatives being developed in case Rio shuts the smelter (for example, data centres, process heat conversion, and green hydrogen plants), the medium-term outlook appears positive for electricity demand.

Secondly, we are attracted to the cash flow generation of CEN, which is important to sustain the business, fund growth projects and return capital to shareholders. Even though FY22 was a lower earnings year due to higher input costs, CEN still generated 42 cents per share (cps) of operating free cash flow, enabling the business to fund a dividend of 35cps as well as some growth capex. When the Tauhara project comes online in FY24, free cash flow generation will increase further and enable CEN to grow its dividend.

Finally, we think CEN is attractive from a valuation standpoint. CEN trades on an EV/EBITDA of ~12.5x, below its New Zealand ‘Gen-tailer’ peers trading in a range between 14-18x. CEN also offers a more attractive yield at 4.6% compared to peers trading at 3.7-3.8%. We see this combination of lower multiple and higher yield relative to peers as attractive, while our internal valuation methodology suggests share price upside of >20% is achievable. CEN is therefore the highest-weighted position of the ‘Gen-tailers’ that we hold in our portfolios.