Risky power retailers lag lines company rewards

By PAULA OLIVER

Investors who took a punt on listed electricity lines companies instead of putting their cash into more risky power retailers have been the big winners since the industry was split two years ago.

But analysts predict that could soon change. A small number of retailers are now settling into strong positions, they say, after taking time to build their empires.

The electricity industry has proven a minefield for investors since massive changes came into effect in April 1999.

The Electricity Reform Act forced power companies to choose if they wanted to focus on retailing and generating, or on owning lines. Legislation prevented them from doing both.

As companies scrambled to buy or sell what they needed to align themselves to either side, some paid high costs for the right to become retailers.

What emerged from the shake-up was two vastly different types of companies for investors to choose from.

Lines companies were seen as traditional utilities - stable, with good streams of income, carrying low risk but a smaller upside. Many of them remain tightly held by community trusts which wanted hard, physical assets.

Three - United Networks, Powerco and Horizon Energy Distribution - are now listed on the Stock Exchange, providing fleeting opportunities for investors.

On the flip side were the retailers - some holding strong generation assets, others spending huge amounts to build customer bases, and overall seen as a more risky option in times of change. But the potential upside was greater than the network companies.

Two years later, those who put their cash into lines companies have come out clear winners.

Since April 1, 1999, shares in United Networks have increased 33 per cent in value. Horizon Energy has rocketed up 67 per cent, and since listing in December last year, Powerco has risen 34 per cent. Retailers, on the other hand, have lost value.

Analysts spoken to by the Business Herald say the lines companies have benefited from two years of volatility in the equity markets, which has seen investors flock to defensive, utility-type stocks.

"The network companies are far more similar to property companies than they are to the electricity retailers," said one analyst.

"They have got a set of assets that they effectively lease out. The earnings streams are pretty fixed. They are dreadfully illiquid. There's not a lot more upside in them."

But they predict there will be further consolidation among the 30-plus lines companies that serve fewer than two million customers - which is where listed companies such as United Networks and Powerco could grow. Powerco is also targeting opportunities to manage lines for other owners, managing water, wastewater and telecommunications assets.

"The pressure will come to bear because you've got United Networks there, very large, very efficient, with all the scale economy advantages," an analyst said. "It's going to become the benchmark against which others are compared."

Retailing is where analysts see the biggest opportunities for investors. Since listing in May 1999, Contact Energy shares have lost 18 per cent in value. Natural Gas shareholders have been hardest hit since the April 1999 reforms, losing 36 per cent. Trustpower has fallen slightly, at 7 per cent.

But, as wholesale prices rise, companies with strong generation assets are enjoying good times.

Contact Energy, heavily criticised for its share performance, is seen as being in a particularly strong position.

"One of the things these current circumstances are highlighting is that not all of the trading companies are utilities," an analyst said.

"If you get yourself on the wrong side of the ledger, like Natural Gas has, you're exposed to volatility."

"Retailing was supposed to be a matter of capturing a large customer base, and leveraging off that base into all kinds of different services in the future," Arthur Lim, of Macquarie Financial Services, said. "Power generation, at the end of the day, is probably the most promising side. Those with hydro generation are in the best position."

Hydro is seen as a good option because its input costs are not as volatile as fossil fuel-based generation - where oil, gas and coal costs fluctuate. Thermal generation is also favoured.

"It's an inescapable fact, that when you look at the energy crisis that has sprung up around the world, in California and now New Zealand, it's a good thing to have hydro-generation," Mr Lim said.

"Edison Mission knew that when they bought into Contact - they have a long-term perspective of how the electricity sector, globally, will shape up."

The crunch is looming, analysts say. Retailers have had time to build their bases, and now they have to perform.