Frank Newman: A new uncertainty

I have for some time now expressed the view that the greatest risk to investors at the moment is political uncertainty. After this week news stories about changes to the electricity market I am certain that is the case. Just to recap, last week the Labour and Green parties jointly announced that should they become the government after the general election late next year, they would regulate pricing in the wholesale power generation market.

So how does the offer stack up? Given the tight controls on commentators regarding the giving of financial advice I will not make a recommendation on the issue in a column. I will instead compare two very basic value measurements for Mighty River Power (MRP) against Contact Energy and TrustPower, which are both listed on the sharemarket - the price to earnings (PE) multiple (being the number of times the share price exceeds earnings per share) and the annual dividend return.

Given current polling puts a coalition of the left ahead of National and its rag-tag allies, the promised change has been taken seriously. The emergence of the Greens as an effective opposition, more effective than Labour in many respects, would by its very nature result in a Labour led coalition much further to the left than the Clark government.

Politics is politics and what will be will be, but in a left wing government the what will be is likely to be fundamental change and uncertainly about the consequences.

Some have argued the announcement was an attempt to sabotage the float of Mighty River Power. If that was the objective, they have to some degree achieved it. (They may instead claim they are being honourable and getting relevant information out into the market place so investors can make a more informed investment decision before applications close.)

Certainly the prospect of socialist control over the pricing of electricity is enough to send a cold chill up the spine of any investor.

The impact on the value of electricity companies was immediate, and significant. As at the close of trading last week, 3 days after the Labour-Green announcement, Contact Energy and TrustPower shares had fallen 9%.

Unfortunately for the government, the missile from their opposition came immediately after talk that Tiwai Point aluminium smelter may close, with a consequential effect that power prices may fall (which in itself would suggest the market is working and there would be no need for the proposed regulation).

Further concern arose when the media reported that while Maori may not own water, they may be able to charge hydro electricity generators for the use of the “container” that houses the water and the riverbeds through which the water flows (care of the fact that they are claiming ownership of those vessels.)

All of these factors are weighing heavily on the float and causing some of the 440,000 would be investors who expressed interest in the float to have second thoughts.

The effect of this uncertainly probably means more shares will end up in the hands of institutional investors and less in the hands of individuals. A fall-off in demand would also mean the price will be lower than it otherwise would have been. The government indicated a price range of $2.35 to $2.80.

Using forecast earnings for the 2014 year, MRP has a PE of between 20.5 to 24.4 times (depending on the  issue price). Contact Energy and TrustPower have a PE of 18.7 times and 18 times last year’s actual earnings respectively. In other words, using this measure MRP is more expensive, even at the lowest possible issue price of $2.35.

On the dividend measure, MRP is forecast to have a yield of between 6.4% and 6.7% in the 2014 year. Contact and TrustPower have respective actual dividends yields of 6% and 7.2%, based on the current share price. In other words, MRP sits between the two.

Comparing these two very basic measures one would have to say MRP shares are not cheap, even at $2.35. 

The real choice for many homeowners is not a choice between Mighty River Power shares or shares in Contact or TrustPower, it’s a choice between buying MRP shares and repaying their mortgage. Of the two, repaying the mortgage is a risk free investment providing a tax free return equal to your mortgage interest rate. Political uncertainty is making that choice a little easier.