Mercury FY2018 Annual Results Transcript

Mercury FY2018 Annual Results Transcript Annual Results FY2018: Analyst briefing transcript 21 August 2018, 11am Transcribed by NASDAQ Pages: 15 Start of Transcript Fraser Whineray: Thank you and kia ora koutou to everyone who has joined us here today and on the call for analysts; also noting that it is obviously open to media as well. We're delighted to present the FY18 results in the summary deck, which we'll be referring to, which was posted to the NZX this morning, and I'm joined here by William Meek, Chief Financial Officer and Tim Thompson, the Head of Treasury and Investor Relations.

So, I'll just briefly go through the deck with William and Tim and then we can take the Q&A at the end. We'll do so relatively briskly, things were well sign-posted coming into the financial year end and a lot of the stuff was already in the public domain.

So, skipping past the usual riders on page 2; page 3, this is a key slide for us, we do repeat it frequently and this was derived prior to the rebranding more than two years ago. There has been one minor tweak to the picture which is a small wind turbine on the right-hand side, which is a nod to our 19.99% stake in Tilt Renewables. But apart from that, it remains unchanged, and guides us.

It does incorporate five pillars, which are in our annual report, which relate to the integrated reporting around sustainability, and we will look to also clearly map that out in this slide next year. Also note that those five pillars that are in the annual report on integrated sustainability are also mapped to the Group KPIs of which I am incentivised, as are the members of the executive and enterprise leaders.

So, the really important and pleasing thing about the FY18 result this year is that all of those forms of capital whether it's brand capital, employee capital, financial capital and also our licence to operate - we think all of those have come forth together and in some instances, in new records.

Mercury's competitive advantage on slide 4, from a year ago: we have consolidated the third and fourth points into substantial peaking capacity; what we have emphasised there is high-performance teams. We've got a highperformance team framework which we're rolling out throughout the business to take project work - and also just core work - into a higher degree of execution, capability, on time, cost, quality and scope and a lot of that comes from teams, whether they're together for an hour or a year, really having a strong understanding of what makes a high-performance team.

The executive started rolling this out through itself, first as guinea pigs in January and that's been through some fairly robust conversations and giving me plenty of feedback, which has improved my performance as well, but ultimately the people’s getting emphasis here because it's the only long-term source of competitive advantage.

To slide 5, you would have seen at the half year we had just a couple of days after the half year launched the electric vehicle campaign around Evie, E-V-I-E. She's been very busy at events; she is not for sale and we'll hear

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more from Ron and Malcolm who are the two chaps who escaped from the retirement village and drive her around town in some advertisements coming up; we have several quite important ones, and also amusing ones, in the can.

In terms of the highlights for the financial year ended 30 June, as I said, it's about multiple forms of capital moving forward together around that slide 3. We have had the record earnings there in the top-left box of $561 million. Yes there was record hydro behind that, but to actually execute and optimise the water you've got, fortunately it arrived relatively steadily unlike the previous year with Cyclones Debbie, Donna and Cook in quick succession, but to optimise the water you've got when you're actually doing one of the biggest reinvestment programmes on the hydro scheme, as well as huge reinvestment in the geothermal plants, is actually a significant challenge and particularly optimising it through wholesale markets and other dynamics.

So, we are pleased with what we leveraged there. It's only an extra 220-odd gigawatt hours of water compared to the previous year, but nearly an almost $40 million uplift, so we've been far better at being able to catch a value from that.

Our brand identity: we've won award-winning campaigns, not just in the sector, but in New Zealand overall against some pretty big marketing juggernauts and that has also flowed through, the same rebranding and some key awards, IBM Connex at Best Enterprise Workplace based on our FY17 engagement statistics, we've brought those forward again and lifted them and also changed management programme at the HR NZ Awards, which was also related to the rebranding.

In terms of our technology platforms, in the middle box there, we have completed the Metrix meter data project and now just rolling out that half-hourly hook-up with a range of retailer customers there. We completed SAP upgrades and customer technology platform upgrades and put most of the SAP functionality into the cloud.

In terms of same business CAPEX, we've reinvested heavily, not just the ICT with Whakamaru, the second unit of four, Aratiatia, the first unit of three and they've delivered efficiency and capacity gains and also had major geothermal shuts, including our longest shut at Kawerau, since it was commissioned a decade ago and we replaced the turbine rotor, creating a spare.

On the growth front, we have acquired 19.99% in Tilt Renewables and that's achieving exposure for us there in Australian renewables transition. We have, as the slide deck notes and we'll come to this later on, been involved in wind for more than a decade and solar for about three years.

In terms of competition, it has been tougher this year. Whilst we still have a relative churn advantage, it has been harder to maintain and I think the market has been strongly stimulated in part by what we've done, but everyone is getting their act together trying to differentiate and develop non-price attributes and it is a very competitive market, but that leads to innovation and that is a good thing.

So now I'll just hand over to William to go through some of the financial aspects and bridging on slide 7. William.

William Meek: Thank you Fraser and welcome to everyone on the call. If you've had a chance to quickly peruse our annual report, you would have seen in the CEO's address that he definitely called out the weather; I think he started it with it rained a lot. Certainly, we thought we had a pretty good last year, but the record performance on a record is something we're extremely proud about.

So on slide 7 you can see a histogram with a number of bars, nice thing about this chart is 2018 in most cases exceeds 2017 levels; energy margin, EBITDAF, NPAT, underlying earnings, ordinary dividends, all up on the prior year. Operating costs, free cash flows, stay-in-business cap is broadly flat on the prior year; new investment expenditure up to $150 million, mostly the investment in Tilt for $144 million and another $6 million again mostly in deployment in new smart metering, so an increase there. You can contrast the $50 million share buyback against the $0.05 special paid in 2017. Ordinary dividends at $207 million versus last year at $201 million declared.

I'll hand back to Fraser.

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Fraser Whineray: Thank you. So, we've covered a couple of points on slide 8 already. Just acknowledge we keep focusing on our three customer promises, which we researched heavily at the time of our rebrand, which are: to make it easy, reward and inspire our mass market customers and continue to focus on trying to find things that are material, at least i.e. 50,000 customers can touch them, because otherwise in a subscale market, doing innovations with just very few numbers of customers tends to be an ineffective base over which to amortise the investment and we've highlighted some of the things where we do in fact have large numbers of customers partaking in some of the differentiation that we offer.

We've also just launched our Mercury app, Mercury Go, which integrates a lot of good functionality, ways to earn Mercury dollars and also links through to what we've been providing to customers for more than five years now, such as through the good energy monitor platform, which is consumption to the half hour, comparison with your neighbours, estimations on bills, estimating what is using the electricity in your house and other functionality. That has been something that our customers have enjoyed and tell us they enjoy for a long time and it's good to see some of our competitors also getting into that data which smart meters were designed to provide. We've also - and we'll come to it later - we'll talk about Mercury Drive as well, but in the meantime, I certainly encourage you to download the app.

In terms of slide 9, there were no high-severity incidents on our employees and contractors this year, which we're delighted with. That is a core KPI, Group KPI for us. TRIFR was down at 0.87 from the previous year, though the previous year was up on FY16, so we haven't yet got below that FY16 figure. Just to note, though, that MTIs or medical treatment injuries and LTIs are typically not a precursor for serious harm or fatalities and so this is something that Nicole Rosie, the Chief Executive of Worksafe, is very strong on and we commend that because if you run around dealing with papercuts, you might be missing someone falling off the scaffolding, and we're very focused on the serious harm as a low probability, even though that is.

As I mentioned, in 2017 we won the Best Workplace off our engagement survey data for organisations more than 750, and we're delighted how the rebrand has helped with our employee value proposition to both retain, develop and attract people in a highly competitive market where the people you're trying to compete with all attract and retain and that employment market has to fight against other large companies as well, whether they're in banking, telco or the like.

We've talked about some of the upgrade investments on technology and plant and we've talked about the favourable hydrology as well. Really pleased to see that geothermal availability is so high, even though we had a large number of planned outages, as we mentioned.

Turning to slide 10 now, we have, with all that activity, maintained costs flat at $214 million for the fifth consecutive year and in our guidance, I think we communicated that we're intending to do that again for the sixth consecutive year in FY19. That always keeps us challenged to make sure that we can still do all those things we've been describing and want to do, yet manage to keep costs under control.

We have invested in growth with the Tilt Renewables stake and we also have now, as of last week, announced a joint takeover offer with Infratil, some 90 days after the original stake was purchased. We've really enjoyed the engagement with the very professional and commercial shop that Infratil is and are looking forward to working with them both through the takeover and some of the opportunities and options that it presents in the future.

We've also invested in ourselves, as William noted, in terms of the buyback, so effectively the extra money we made from the water is now put into treasury stock for release at a later date. So it's a kind of innovative way of storing water in Lake Taupo.

In terms of the dividend, we are signalling, for the eleventh year, ordinary dividend rise of $0.155 – that's slightly elevated from what might have been a 2% lift because of the lower number of shares on issue; when there are

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fewer shares on issue, you get a bigger share of the profits and that is part of the outcome for those that do stay, even during a buyback.

We recently also announced just in terms of growth a bit of R&D with respect to Mercury Drive. You can go to evdrive.co.nz and you will see a subscription model for electric vehicles. The Tesla has already gone, sorry, or there are a couple of those; there are a few more coming, I understand, with our partner in the rental car space there. But that is just a bit of R&D and then we'll see what data we get out of that, and the customer experiences we get from that. We're delighted with that.

We also, just lastly, in terms of sustainable growth, had a full Board and management session with the Cambridge Institute of Sustainable Leadership to focus on global matters related to climate change.

So now I'll hand over to William to take us through some of the market dynamics.

William Meek: Thank you Fraser. So, we're on slide 11; earlier this morning I was talking to Phil Gibson, our GM Hydro Wholesale and he was perusing the deck and said, ‘EVIE looks good, but check out this rotor’. So this rotor is 80 tonnes, it's the first of three to go into Aratiatia, our first hydro station on the Waikato River, it's ANDRITZ supplied, it's assembled on site, so very good to see after 50 years of hard service, that station getting a pretty major refresh over the next three years.

Turning to page 12: really, this slide summarises our market thesis and really just works through how wholesale and particularly end-user prices change with supply and demand dynamics. Encouraging to see demand growing on both a nominal and adjusted basis during FY18, up almost 1%, mostly driven by growth in the first half. We'll talk more on that shortly.

We did see increased price volatility, so price levels certainly up, up almost $30, sort of low-80s from low-50s the year before in the central North Island. Haven't really seen a lot of movement in futures prices and we'll talk to some slides about that, because obviously that feeds through on to commercial industrial pricing, it does form the COGS for retail which then flows through to churn and potentially increases in retail prices as that wholesale price moves, so question marks there on those next four, so we'll talk to those shortly.

Slide 13: just some breakdown of demand – again, pretty much a recurring theme, when we look at the sectorial changes in demand across New Zealand; still got a trend of slowly falling industrial load. That excludes the New Zealand aluminium smelter at Tiwai. Very encouraging to see potline 4 restart; that's expected to contribute about 0.5% of demand growth next year and over 1% on an annualised basis, so that is very positive for the sector and certainly for the longevity of the smelter.

Again, common themes: you're seeing effectively demand increases in urban areas, population growth remains strong, albeit average household consumption continues to decline slowly on the back of better energy efficiency.

Rural area again up, and irrigation relatively flat for the year; net-net around 1% change for demand, again very positive in terms of pricing and ultimately supply dynamics.

Turning to slide 14: again some familiar charts here, really showing the situation between the difference between mean storage levels in the North and South Islands and wholesale price for the month. So again, a bit of a game of two halves; if we start with the North Island on the right, so that's dominated by the Taupo catchment, which is controlled by Mercury, you can certainly see there we've had two years where the lake's largely been above average, so again, reflecting both 2017 and 2018 being wetter than normal years.

Certainly the saying, ‘what do you call three months of rain in New Zealand’? Of course the answer is ‘summer’ – rings true this year, as it did last year also. So, you're seeing quite a strong correlation there between particularly that wet conditions in the North Island, yet seeing prices remaining relatively elevated. Contrast that to the South Island, where you've got almost an even split between wet and dry in terms of the delta on storage. Certainly, again a recurring trend theme where obviously storage in the South Island falls back, prices tend to rise.

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So, I'll flick over to 15: really, this summarises the discussion we've just had and what does that mean? Certainly, Mercury you can see in the first line chart, on an EBITDA to total generation basis, definitely punching above its weight compared to the big four generators in New Zealand, so earning around about the low $70 a megawatt hour EBITDAF for each megawatt hour produced.

You can see in the second chart, again, a much higher GWAP, again for the North Island, again reflecting the benefits of our firming and peaking across that catchment, but also the inverse correlation between our inflows and price. Typically, the South Island, when its dry prices tend to rise, and generation levels tend to fall. You get the contra when it's wet. Quite a big difference there in terms of that competitive advantage for Mercury, relative to our South Island peers.

Touching now in terms of those wholesale prices feeding back into the Futures market, certainly the Futures market's been unresponsive to price volatility when we look out into the medium term. So, when you look beyond the next six months, which is affected by current spot prices and current hydrology, you're really seeing a relatively narrow range of trading in that $70 - mid-$70 to mid-$80 range on the Otahuhu ASX Futures price. That's in spite‌ the increase in that wholesale price volatility.

We've actually found ourselves in the situation this year, when you look forward this Futures is trading at around $75 a megawatt hour, a good proxy for what an industrial contract energy-only would be sold for if it was baseload, against‌a wholesale price average of about $85. So, we're running at about a $10 negative differential there between the actual Futures forward price and actually prevailing spot prices at the moment. It's a pretty interesting dynamic and something we haven't observed in recent history.

Again, you look at that chart there on the right, Otahuhu Futures and Spot Prices, that ASX Futures line looks pretty straight, like an All Blacks prop back, not an Aussie one. Very, very stable ASX prices as we look forward.

Turning now to the Retail market, again some familiar slides, really reflecting the churn dynamics. As Fraser has already touched on, the market is fiercely competitive and you can certainly see that in the first chart in terms of the net losses and gains there.

If we look at EA ICP switch data, which this is based on - so it is slightly different from customers, because some customers have multiple ICPs, and it does ignore new connections, total switches last year in were 71,000, and 78,000 out. So, it does - there's a lot of effort, Mercury's not alone in that. Certainly, we're seeing that across the board and we'll see some more in the next slide.

It certainly does feel a lot like the Red Queen's race in Lewis Carroll's Through the Looking Glass. If that's not familiar to you, it goes something like this; the Queen says to Alice, now here you see, it takes all the running you can do to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that.

So, Mercury certainly looks forward to running twice as fast this year.

Turning to slide 18: this is really just showing some churn stats across time for the major brands in the retail sector.

You can certainly see a congruence of churn stats across New Zealand. So, a big grouping there in the middle.

Certainly, Mercury and Contact doing pretty well in terms of the lower churn. Certainly, the minor brands very, very high churn. Certainly, when we look at Trustpower - when we move outside the TECT area in the Tauranga or Bay of Plenty area, again you can see certainly quite a rising churn trend there.

The chart on the right really showing trader churn in the Auckland area, so that's churn again where you haven't moved. You just customers within premises just switching between retailer. Again, you have got some quite big differences there across the Auckland market, again Mercury brand punching well above its weight.

I'll hand back to Fraser to just give us a rundown on some of the policy focus.

Fraser Whineray: Yes. Turning to slide 19 there, we've summarised a couple of points on the various policy areas for the new government, on the Electricity Pricing Review which chaired by Miriam Dean, QC. A very strong panel

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there, and we're looking to hear from them in September 2018. They are undertaking extensive engagement and looking to get wide input into the issues they are trying to tackle, which is related - seem to be focused quite a lot on customer access, affordability, energy literacy.

In terms of the ICCC, the Interim Climate Change Committee, there has been strong engagement with them. They have more PhDs than Shortland Street. They're experts in all their fields, and that - they are really doing a thorough piece of work, and as I said engaging extensively to get the century's worth of experience in the sector from many of its participants. We think this is very strong. They are certainly focused on a low carbon energy future and rather than just simply the narrow focus of 100% renewable electricity by 2035.

In terms of the intersection of course between various legs of the trilemma, I'm delighted to note that the ICCC is engaging with the EPR Group, the Electricity Pricing Review Group, because renewability, reliability and price are all interlinked, and they're acknowledging how the trifecta works in New Zealand at the moment and how delicate it can be.

In terms of thermal fuel, there's been various statements made on that. That means the chips are on renewables if we go for zero carbon 2050, et cetera. No doubt you would have seen the Productivity Commission, led by Murray Sherwin there - expansive report about the expectation on renewable build over that time and the importance of keeping electricity as competitive as possible, to substitute as much non-renewable energy in the market as possible.

There's a bit of conversation about hydrogen. That's not really a threat. In fact, it's an opportunity. I'd like to see it exported. I think it would be a great energy export. But, know that if there is a hydrogen economy that develops in New Zealand you need three-times as much electricity for that as you do for direct use of electricity, say in electric cars, so the fact whether it's a hydrogen or electric car doesn't actually make much difference to us on the downside.

TPM, there's a new chief executive at the Electricity Authority, and we look forward to engaging with him when he starts in September. We note that there's recent movements in the carbon market as well, as carbon prices are pushing up close to the $25 cap. That's another regulatory matter.

In terms of wind, we thought - we had mentioned various wind things, probably only taking a bullet point or two, in previous decks as we've presented, and some people might have got a bit of a surprise about wind when we made our investment in Tilt. Just want to put together a slide - well, we've put together a slide here which just shows how long that journey has been, and for more than a decade. This is sort of how long and hard it is to build platforms in countries, and that's part of why if you want to - for us, when we're looking at the Australian thesis, it went via a very capable partner in Tilt, majority owned by Infratil, and hopefully privatised shortly, because setting up independent platforms in foreign jurisdictions and getting a pipeline running is actually very hard, and this is an illustration of it for us in New Zealand.

Wind and solar, but particularly wind, very strong in terms of a fuel system for electricity, and a lot of that innovation has been driven by procurement in Europe, China and US, which has led to large volumes going through manufacturing.

As we turn to slide 21, I'll hand over shortly to William, to talk about some of the financial highlights. Just on slide 21 there is a sneak preview of a 1 megawatt/2 megawatt hour battery, TESLA battery, at the site, the Mercury R&D Centre, at the mothballed Southdown power station site in Penrose. For all those infrastructure-philes out there, it's a good-looking bit of gear and will look even better when we put our Mercury EV Ford Fairlane next to it tomorrow with Doctor Megan Woods, the Minister for Energy.

William.

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William Meek: We're on slide 22 now. Again, these numbers should be familiar to you, but for emphasis: EBITDAF at $561 million, a record. NPAT at $234 million, also a record. Free cashflow at $259 million, also a record.

Embedded in that is a record cash tax payment of $102 million, so the Crown this year will - between dividends and cash taxes, will read $205 million from Mercury. Share buyback at $50 million, again reflecting the buy - a buy-low strategy at $3.21, share price today, $3.43.

Tim will talk about our gearing ratios. You can see there on the normalised basis at 2.3x debt to EBITDA. Again, ordinary dividends at $0.151 per share, also a record. So, it is a year of financial records for Mercury.

I'll hand over to Tim. Tim Thompson: Good morning everybody. We're on Slide 23 now, so I'll just talk about capital management. So the graphic on this slide is a new one for us, but it's essentially the same thought process that we've communicated in prior years. It illustrates how the Company applies cash generated from business, firstly the couple of ‘musts’. So, we continue to invest to maintain our current assets and then we intend to continue to pay ordinary dividend consistent with our dividend policy.

Beyond that, what's left is applied to either returning additional funds to shareholders, investing in growth, or repaying debt. So, stepping through FY 2018, operating cashflow was $371 million. You take away the stay-in-business CAPEX of $112 million, that gives us our free cashflow of $159 million. We declared an ordinary dividend of $207 million, and ultimately that leaves $52 million to consider that circle there.

Through the year we did a buyback $50 million. That consumed most of the excess funds, but we also invested $150 million, again $144 million of that is in Tilt. The difference obviously being funded by debt. So, debt's up $111 million at the end of the financial year.

From that, moving to slide 24: a bbb standalone credit rating remained the key reference point for the Company's capital structure. We get a one-notch uplift for the Crown being majority owner, so we have a corporate rating of BBB+. Key credit metrics for that rating is 2x to 3x debt to EBITDAF. Mercury has refined this range slightly to be 2.2x to 3x. This acknowledges that treasury stock that we hold, about $125 million at the moment, and the additional balance sheet flexibility that affords us.

In the absence of compelling growth prospects, the Company is likely to target the low-end of this range. Again, this acknowledges the Crown, the Crown's minimum equity requirement, and the Company's reliance on them to support any further capital raising or equity capital raising.

At 30 June, the Company's debt to EBITDAF ratio was 2x, but however if you normalise for the record year in the hydro we had, you will get to 2.3x.

I'm going to hand back to William to talk about guidance.

William Meek: We're now on slide 25: start of FY19, we've come out of the blocks pretty fast again. So, you can see there - guidance is $515 million for this year's EBITDAF. That's on the back of a hydro forecast 200 gigawatt hours higher than mean, at 4200GWh. Of course, that guidance is - remains subject to hydro volatility, wholesale market conditions, and any other material adverse events, significant one-off expenses or unforeseeable circumstances.

Ordinary dividend guidance is again up strongly, 2.6% to $0.155 per share. OPEX is again forecast to be flat. Stayin-business CAPEX is at $95 million, down on last year's levels. We'll speak to that some more shortly. Again, noting the roll-off of long-dated interest rate swaps yielding and expected cash flow benefit around $20 million. That will be partially offset obviously, by a higher level of gearing which will lift interest expense a little.

Just a quick bridge there on slide 26 between this year's actual EBITDAF at $560-odd million, down to our original guidance of $500 million: that was at the start of the year again, adjusting mostly for that very strong hydro

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generation level. Then you've got a number of normalisations. So, you'll shrink that by another $15 million if you were going back to 4000 gigawatt hours. Again, the guidance this year is up 200 GWh. So, it's about $15 million.

So, the prices are different. Last year's prices are forecast higher than this year's.

You do have a $15 million uptick on other. Part of that is IFRS. You can see that in the appendix. There is about a $5 million adjustment for IFRS 15 and 16 flowing through this year's guidance number, and then $10 million of just business improvement, leaving us with that 2019 guidance of $515 million EBITDAF. We've touched on this again - just the long histogram from 2008 through 2018 so, 10 years of ordinary dividend growth. We're forecasting a further year this year at $0.155. So, when that is realised it will be the eleventh year of ordinary dividend growth for Mercury. That $0.155 per share does reflect the recent buyback which obviously reduces the amount of equity on issue and therefore can increase the cents per share payout.

Finally, just summarising with capital expenditure and investing in our long term capability. 2018 you can certainly see an increase and a step-up in spend on both investments and CAPEX. The $150 million as we said largely driven by the Tilt investment and $112 million really reflecting that ongoing IT and investment in our hydro business during FY18. FY19 guided at $95 million for stay-in-business.

I'll hand back to Fraser for concluding remarks.

Fraser Whineray: So that will summarise the formal part of the presentation and we're happy to move into Q&A. But before I do so I just want to commend the executive and everyone at Mercury and the Board for their aligned effort in these results. As I said, the rain can fall, but it takes a heck of a lot to capitalise on it the way that we have, and also all of the other improvements which set us up for a positive outlook ahead.

The Q&A slide finishes with the, of course, the evdrive.co.nz. That's what you'll see if you open the website. You can put your name down for a ‘try before you buy’ Tesla there. If you're not sure where to charge, make sure you do download the PlugShare app which is New Zealand's electric highway. You can find that on the app store as well. That will tell you where every charger is in New Zealand thanks to crowd-sourcing of information. So, thank you everybody. Now I'll hand over to Q&A. Operator: Thank you. If you wish to ask a question please press star one on your telephone and wait for your name to be announced. If you wish to cancel the request please press star two. If you are on a speakerphone please pick up the handset to ask your question. Your first question comes from Grant Swanepoel from Craigs Investment Partners. Please go ahead.

Grant Swanepoel: (Craigs Investment Partners, Analyst) Good morning team. Just a couple of questions. First one, regarding Will's slide on page 26, the guidance for $515 million. Can you just talk us through what a normalised number looks like, in that if you interpret that slide, you're talking about $500 million less $15 million - so $485 million as a normalised FY18, plus $5 million for the IFRS gives you $490 million. So, what that implies is that there's only a $10 million uplift over two years in organic earnings. Is that about right or is there something else I should be reading into that?

My second question is: in regards to the Fraser commentary around wholesale prices are up but forward curve is down. Contact mentioned that Genesis has been very disruptive in the C&I market. Has that had a major influence on the forward curve and you think when that eases up once Genesis has right sized its book that we could see the forward curve lifting as per the wholesale price lift? Thank you.

William Meek: Okay Grant the first question - so the - as you can see on slide 26 the shaded boxes, essentially those are largely known. The original guidance of $500 million was issued last August. That assumed the 4150 gigawatt hours of extra hydrology. You strip that back and you are going to end up at that $485 million and about $5 million for an IFRS adjustment as we look forward which takes you to $490 million.

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Then again in terms of the other business performance in that other area you've got another $10 million. So you've moved forward $10 million from where you were last year ignoring the accounting effects.

Grant Swanepoel: (Craigs Investment Partners, Analyst) So that's $10 million over 2 years, that is, not just the 1 year?

William Meek: That's just 1. It's 2018. It's $490 million. You would go to $500 million normalised now.

Grant Swanepoel: (Craigs Investment Partners, Analyst) Okay. Thanks.

Fraser Whineray: Yeah and second question on the C&I. You know there's probably multiple factors Grant behind why the ASX curve is where it is. It seems strange that it's got a negative sort of swap spread implied at the moment when it should be the other way round. We are seeing increasing volatility as per the dot chart which we had in the presentation contrasting correlations with hydro storage and spot prices there moving above trend.

So we've got no specific comments to make on any of the participants. But it's largely if there is inefficiencies that we see in the market in the near term we'll look to trade around those convictions. We've had a very good year in trading around ASX and FTRs. But ultimately we do want to - we do keep an eye on that ASX curve as it relates to C&I pricing per the wholesale market thesis that we outlined on that slide. We'd look to see potentially that move up over time. But it is strange to have an inverted swap spread at the moment. William would you care to add anything to that?

William Meek: Yeah, I think the other consideration is we potentially end up with a forward price lower than your view of wholesale spot prices for a vertically integrated player. One way to manage that is essentially to just shrink your C&I book. So I think we're not renewing or bidding higher and therefore losing market share as a mechanism effectively pushing more sale further into a spot exposed position rather than into the ASX. You've got sort of two - you've got two levers you can run, either not sell C&I or buy ASX. So I think that you're seeing - you get a bit of that sort of dynamic happening where all the big players obviously have relatively large C&I exposures which on a 3 or 4 year cycle are effectively all rolling through in terms of renewal.

I think too that just - the volatility has definitely increased. You're seeing quite a lot of sensitivity depending on what thermal assets are available. So they've obviously got slower ramp rates. Where they’re not available, the interplay between demand changes and wind availability is having quite profound effects. So you're seeing prices that are very soft and then again like this morning again they're very, very high. So you are seeing a lot more volatility.

That’s great for Mercury because with the flexible hydro portfolio that we have it really plays to a key strength of the firm in terms of - whereas when you've got very stable, flat prices, that flexibility is worth very little.

Fraser Whineray: Thanks. Grant does that help?

Grant Swanepoel: (Craigs Investment Partners, Analyst) Very much so. Thank you.

Operator: Thank you. Your next question comes from Andrew Harvey-Green from Forsyth Barr. Please go ahead.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Morning team. A couple of questions from me as well. The first one is also related to the guidance and the plus $10 million. So I'm just trying to get a bit of a feel for in terms of where you see that plus $10 million increase coming from. Given it's not operating costs related I presume it's - you've got some sort of price increases coming through or volume increases metrics. Can you give a little bit of colour in terms of what's driving that $10 million increase?

William Meek: Yes, mostly it's coming out of energy margin. It's mostly focused on just improving the efficiency of how we're transacting. So it's really looking at how we're reconciling, how you're passing through cost structures to end users. More accurately reconciling your key input costs. You've got $50 million of metering. You've got $400 million of lines charges. Really just going line by line.

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Am I charging this customer correctly - I'm getting a 3-phase 100 amp meter charge from the metering company. Is that actually being accurately reflected through to customers? So you've just got a whole lot of complexity. You're looking to just improve through systematic review of systems. I think we've got some views around just the sort of just trading performance of the firm and potentially improving that a little bit. But it's a combination of a whole lot of small things mostly in the energy margin. It's not about price changes, though price changes may flow from that if you've got particularly non-cost reflected pricing to consumers.

Because we know there are pricings in the system which doesn't actually reflect the costs we've been charged just given the passage of time and then the accuracy of the information when those prices are actually formed. So it's really just about getting down on the data and making sure that actually the costs and the revenues are matching up accordingly.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Okay. That's great thanks. The second question I had was just around the wind and the New Zealand wind options you've got. I guess in the past you've sort of talked about not seeing any new generation going forward.

I'd just like to get a sense for - of Turitea, Puketoi - which of those two do you prefer? When do you think they might get booked from your context - from your perspective? I guess finally how do they stack up relative to some of the sub $60 prices that we're hearing from some of your competitors and Tilt for that matter?

Fraser Whineray: Yeah, the wind prices have been coming down. In terms of physical locations Turitea is a more natural build ahead of Puketoi and also due to consent management as well based on a lot to do with transmission et cetera. So that would be a preferred sequence. But we'll always continue to evaluate the positions on those farms.

In terms of - we think they are the best or best equal sites in the country. Wind farms can be built in stages more easily than probably some other fuel systems. In terms of some people saying they've got sub-$50 it just - I think the next question you've got to ask is what's the escalator you've got on that over the next 25 years.

Because I think that - also is that a delivered price or is that a normalised price against the wholesale market noting that wind does attract a negative GWAP in New Zealand because of its correlation and for some reason it not seeming to be optimised against hydro production which still baffles us at times. So that's kind of our view on that.

Of course we've got no future date to provide you Andrew on when or if we'll build any of that.

Andrew Harvey-Green: (Forsyth Barr, Analyst) That's great. Thanks.

Operator: Thank you. Your next question comes from Aaron Ibbotson from UBS. Please go ahead.

Fraser Whineray: Hi Aaron.

Aaron Ibbotson: (UBS, Analyst) Hi there, good morning gentlemen. I've got three questions if I may. So first of all I'm just curious to hear your thoughts on your Tilt investments a bit further, and specifically I'm interested to hear if you feel that you have or would realise any tangible, or intangible for that matter, synergies. I appreciate you like the investment but I also appreciate that you're not an investment company, and there are surely many investments out there that you're not considering.

Secondly, just on capital distribution and your policy, do I read it correctly that your preferred option now is the occasional share buyback rather than special dividend as a preferred option if you do find yourself with a bit of excess capital? More specifically for the next 12 months should the Dundonnell development not happen should we think about that as a reason for share buybacks, and should it happen as the reason that it wouldn't be any buybacks?

Then I had one final quick question and that's just if you happen to have at hand what percentage of your customers are currently not accessing prepayment discounts. Thank you.

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Fraser Whineray: Right, thanks Aaron. Firstly, on the investment, yes, we're not an investment company in the sense of like you would be as a buy side investor would be running a KiwiSaver fund. As you've seen we're looking to take it private and that puts it in a similar framework to the more than $1.5 billion of joint ventures we have around geothermal fuel systems, which is a position we're comfortable with - both in the case of Tauhara North No 2 Trust and Tuaropaki. So we are used to partnerships around renewable generation which can be in the majority or the minority as our track record has shown.

In terms of where things go from here, I think there are a range of options and that's something that Infratil and the team, also Morrison & Co, are very astute at working through on a range of asset classes - is how to create optionality and actually capitalise on that.

So 90 days ago we bought our stake. Now we're looking at taking it private and there's probably another three or four different ideas floating around. I'm sure you could have a good guess at a few of them which may present some options later on to further add value to that, and being invested in wind and invested in Australia certainly sharpens one's focus on both of those technologies. So we see some things we can bring to the table but we'll certainly be learning a few things along the way.

So that's how I'd describe the Tilt investment and to think about it more as a series of chess moves rather than a one-off thing which I think, as we've already shown, it's not a one-off thing. It is something that continues to progress and will be actively managed certainly from our end, and you can assess Infratil as a very active manager as well.

I'll do the last question and then I'll hand back to William to talk about the middle ones.

My understanding on the percentage of customers that don't access prompt payment discounts is low at around it's probably the high single digits or low double digits. It's probably in that order. William Meek: I've got about 8%.

Fraser Whineray: Eight per cent - well there's William with the numbers, good man - and so that's about where it is at the moment. Let's just remember the prompt payment discount also has - there tends to be other things associated with that, like are you getting your bill online as opposed to posted, how do you pay. There's quite a few components as opposed to it simply being a prompt payment discount, but that's the figure for us, and ours is set at around 10% or 12% if you are doing those online things.

Back to William for all those other questions, 2 and 3.

William Meek: Aaron, so I think in terms of the decision between special dividends and buybacks it's really pertinent to refer back to the slides Tim talked to, slide 23, which is the capital management slide read in conjunction with slide 28, which is essentially your investment or CAPEX slide.

So you can certainly see if you look at 28 CAPEX - growth CAPEX other than metering was pretty minimal through that 2014 to 2017 period. So you had - that also coincided with the Company either executing buybacks or paying special dividends which again reflect that capital management diagram. You were generating effectively cash flows beyond your ordinary dividend payout. They were - your mortgage was at a low level so you weren't repaying debt, you weren't investing in growth, so that effectively meant capital returns to shareholders.

So certainly paying the right amount of tax is a consideration. There is no doubt a share buyback is more efficient from a tax perspective than an unimputed special. I can say personally I'm not a fan of unimputed specials but then buybacks need to be also for value.

So we look forward. This year you had $150 million of growth CAPEX. Clearly the mortgage was rising which is why putting the buyback aside you're not seeing a special declared with these financial results given that buyback occurred back in May.

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If we look at the Dundonnell commitment, both Infratil and ourselves have committed to that Dundonnell project assuming it gets VREAS support. That's AUD$60 million for our share. Again pre-cash flow-wise when you run through that operating cash flow right through to ordinary dividends, you're looking at about $50 million bucks a year of surplus cash. That Dundonnell project by itself will essentially soak that up.

So again you go back into the circle where you've got three decisions: repay debt, return further capital to shareholders or invest in growth. Essentially the Dundonnell project will effectively be using the free cash flow, so to some extent you've got a relatively clear solve there in the absence of abnormal returns et cetera.

Anything else on those?

Aaron Ibbotson: (UBS, Analyst) Very clear, thank you.

William Meek: Thank you.

Fraser Whineray: Thanks Aaron.

Operator: Thank you. Your next question comes from Stephen Hudson from Macquarie Securities. Please go ahead.

Fraser Whineray: Hi Stephen.

William Meek: G'day Stephen.

Stephen Hudson: (Macquarie Securities, Analyst) Hi guys. Look I just had a couple of questions - maybe two for Will - just on the guidance. I'm not sure if you put it into the pack but if you can clarify what your geothermal assumption is for FY19.

Also just carbon prices - what you're assuming in terms of your impost there. Then C&I recontracting - either drag or benefit going into '19 so those three would be useful.

Secondly, just on the hydro refurbishment, you talked about reasonably material efficiency and capacity gains. I just wondered if you can help us quantify those gains.

Thirdly, on Metrix, I know your meters are coming up for - their nine or 10 year anniversary since you first started installing them. How long do you think those smart meters will last based on what you've seen.

Then just a final one if I can sneak it in - just your expectations for the EPR preliminary issues paper next month and what you think the focus might be.

Fraser Whineray: By my maths you've got six questions.

But look the geothermal assumption will be around the 95% availability of our stations and we do publish the headline capacity and you can back reference to our operating statistics last year for that production level.

William Meek: Just on that one, so you should expect it'll be higher than last year simply because we had major maintenance undertaken last year so we've got less maintenance undertaking on the geo-fleet. You should see it higher than last year.

Fraser Whineray: Yes. On carbon prices, we're largely insulated from the volatility. In fact, we've tried to capture benefits from having some surplus carbon which we I think pushed out the door in FY16 - or was it '17 - and because we have long term carbon offtake contracts which largely match the Mercury, which excludes the joint ventures - the Mercury carbon position including the gas sold to our customers which is about 60,000 tonnes a year of carbon.

So we're largely insulated from that in terms of the volatility given those contracts, though the cost of those will roll through slightly more than it has in previous years because in previous years we have been using PREs which

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were zero cost carbon, which was secured at the time of building the geothermal power stations under a carbon reduction scheme because they displaced thermal fuel.

In terms of hydro gains, typically on a unit we do talk about headline so Whakamaru 25 to 31 megawatts. That's peak efficiency and also helps with water throughput and less spill pass there, but normally you're looking for 5% efficiency upticks. It's the efficiency which is conversion of tonnes of water into megawatt hours which is the most important thing for getting more energy. The peak capacity is useful for covering some positions at times.

So typically you'd expect 5% so from Whakamaru the four years of that you'd expect to get about $3 million of additional - or 34 gigawatt hours at that station or $2.5 million, $3 million per annum of benefit.

So if the hydro station notionally had a 4000 gigawatt hour average, which it never comes in on but 4000 average which we use for budgeting, from start to finish on this hydro refurb thing - which has been running for about six years and has got at least that long to run in varying degrees depending on procurement et cetera - we'd expect to be around another 5% uptick on the stations that we upgrade. So that could be another 100 or so gigawatt hours end to end - 100 plus gigs.

William Meek: I think at Aratiatia you're not going to see those types of gains because of the three units only one of them's getting a new runner and the other two are effectively getting refurbished runners that are existing, so you're not going to get the efficiency uptake because it's the same runner, that’s all.

Fraser Whineray: So at Ohakuri we did the runners. At Whakamaru we did top and bottom, Aratiatia did one runner and then Karapiro that'll follow will be the runners as well. So not all of the 4000 gigs gets a 5% tick up and we just chip away at those things over time.

Let's see. EPR - well we'll wait and see what their issues’ list comes up with. As I've commented earlier I think the - strongly lead with someone who does understand a lot about the sector and Miriam Dean, QC, and they do have some expertise on - strong expertise on that panel and they have been engaging widely.

But I think they will be focused on a couple of things like access, access to prompt payment discounts which is one of the questions earlier today from Aaron, and they'll also be looking at things like low fixed charge tariffs and the energy minister's also very focused on making sure that the settings are right for new investment. That means that excess [variablisation] of lines charges which we see at the moment is sending a wrong signal and will need to be corrected.

So whether or not that happens through the EPR or another mechanism we will see. There's certainly a lot of work being done on that last one.

William, C&I recontracting and there was something to do with Metrix.

William Meek: Okay. I can't even remember what the questions were. Can you repeat the questions Stephen?

Fraser Whineray: Of C&I and Metrix Stephen.

Stephen Hudson: (Macquarie Securities, Analyst) I think you've covered it all up. Is there anything in there for C&I recontracting drag or benefit in '19?

William Meek: You’re probably seeing slight headwinds there, given where the ASX is trading. It’s come off just fractionally, but again, on an average year you’ll be talking, I don't know, 500, 600 gigawatt hours rolling out, and recontracting whatever the ASX price is in that period. Obviously you seek to time that when the ASX is the highest, but the demand’s not silly, they’re also seeking to contract that when it’s lowest.

Stephen Hudson: (Macquarie Securities, Analyst) Then just finally, how long do you think you can get out of the smart meters?

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William Meek: I think certainly based on the return rate from those, it looks like you’ve got plenty of life left, so well beyond 10 years. We’re coming up 10 years now for the first meters, we started our big programme back in ’08, but they’re working fine. So certainly the return to shop at this point is minimal.

Fraser Whineray: You’re seeing that core value add now, as we get into that asset management of recycling, to think about CAPEX spend with regard to that, but that’s still what we consider more medium term rather than near term.

Stephen Hudson: (Macquarie Securities, Analyst) So do you think you could get 20 years out of them?

Fraser Whineray: I think 20 might be a bit of a stretch, but if they do that that’ll be great. If you know how to do that, let us know.

Stephen Hudson: (Macquarie Securities, Analyst) Thanks guys, that’s great.

Operator: Thank you. Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. Your next question comes from Nevill Gluyas, from First NZ Capital. Please go ahead.

Nevill Gluyas: (First NZ Capital, Analyst) Good morning, team, now let me see if I can work through the questions that have already been asked. So just a couple of details, perhaps if you could elaborate a little more on Metrix, because it’s useful to know just what the EBITDA contribution was this year.

Then I guess the question goes to the Landis+Gyr deal with TrustPower, whether or not there’s any risk of these meters starting to become bypassed or replaced, so what’s the term of the contracts, the deals done for Metrix with retailers? So that’s one question.

Just a confirmation around your flat OPEX guidance, I'm assuming that amongst those IFRS charges there’s the lease reductions there of $6 million, I presume those come out of the $214 million? The other $3 million relating to the OPEX, I presume that is above the OPEX line, but it’s just useful to confirm that.

Third question, just on your fixed-term contracts, the number of customers signed to fixed-term contracts, it’d be useful just to get a track on that. Last question, just relating to the GWAP/TWAP discussion, always a favourite item on the agenda, just which TWAP are you measuring against? Just against my quick examination of stats, it looks like it’s the local plant TWAP, as opposed to say, the Otahuhu nodes, which would be indicated for us by the ASX prices. Thanks.

William Meek: The first one on Metrix split, so if you look at note two you can see other segments, that is essentially Metrix, so you can see an EBITDA there of 29, so that’s mostly going to be Metrix.

Fraser Whineray: In terms of the TrustPower Landis+Gyr contract and displacement, well we have contracts with TrustPower when they switch onto Metrix meters, and we don't own the meters down in Tauranga, or wherever it is, that are largely going to be displaced, so not aware of any particular displacement risk there, and Metrix services all retailers.

The old ripping meters off the wall and substituting like-for-like doesn't happen really, hasn't happened for a long time.

William Meek: So just on that, essentially there’s a pretty standard-form HHR meter supply arrangement, so day after you’re providing effectively the daily read and the half-hour read for all smart meters, to retailers. That’s pretty much the generic service. So there are discussions about going to more real-time supply of information, that is a lot more complicated, you could go to greater time increments, but there’s no value in that, given that the market price is half hourly.

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Some inbound around potentially looking at gas smart metering, which is again interesting, probably good from an accuracy perspective, but again, the gas market doesn't really price itself on an even daily basis. So it’s a reasonably generic product offering until you get to something like GLOBUG, which is a prepaid service, which is more complex. But again, that tends to be bespoke arrangements, and certainly be enabled across the AMS and Metrix fleet.

Nevill Gluyas: (First NZ Capital, Analyst) And contract terms on those?

Fraser Whineray: In terms of pricing that’s around 140,000-odd customers, and that rolls on and off every day because there’s no monster anniversary dates there. That’s an ongoing dynamic. I’ll let William cover off the IFRS matter, relating to the lease, that you described, and comment on…

William Meek: So probably $5 million. $4 million of that’s related to leases, and about $1 million is related to particularly 15, so revenue recognition. So most of it is a consequence of lease change. The TWAP question, so yes, that is measured at the node, so obviously it’s the generation’s average, with the GWAP at the node versus the TWAP at the node, so we’re higher both on a TWAP and GWAP basis, given that prices in the North Island are typically higher than the South Island.

So it’s not referenced to Otahuhu or Haywards, or any reference grid point, that’s actually generator dependent.

Fraser Whineray: That help, Nevill?

Nevill Gluyas: (First NZ Capital, Analyst) Possibly. Just whether or not you wanted to give a bit of colour on the contract term for those metered leases, is there any kind of anniversary dates coming up in the next five years, or are they for that 10-year life, remaining a lease?

Just clarification on the $214 million OPEX, and whether or not I should read that as $205 million, which has two items of cost out at the IFRS lines, or just $214 million less $6 million for the leases?

Fraser Whineray: We’ll come back to you on the Metrix stuff when we catch up with you later, Nevill, I need to chat to Matt Olde in particular, and William on your $214 million.

William Meek: Yes, I’ll take that offline and rec that.

Nevill Gluyas: (First NZ Capital, Analyst) Okay great, thank you.

Operator: Thank you. There are no further questions at this time. I will now hand back to Mr Whineray for closing remarks.

Fraser Whineray: Thank you all very much for joining us for this investor presentation on FY18 results, and thank you all for your interest and questions that were shown in that.

We look forward to catching up with the rest of you over the coming couple of weeks, to examine things in more detail.

Good luck, everybody, ngā mihi nui, kia koutou katoa.

End of Transcript

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