Idea of the week: Ausnet, delivering electricity across Victoria, Australia

Highlights

- The bulk of Ausnet’s revenue is derived from electricity services segment (electricity distribution: 48%, electricity transmission: 29%), constituting 77% of total revenue in FY23.

- Ausnet, as a provider of essential services, operates in a highly regulated environment overseen by regulatory bodies. The beauty of a regulated business is that while it limit windfall profits, it still enables company to earn a fair profit margin.

- The consistency in profit is corroborated by Ausnet’s operating margin which is in the north of 30% in the last 5 years.

- Operating cash flow has steadily increased in line with the growth in utilities assets. On the other hand, Ausnet’s capital-intensive nature elevates its overall leverage ratio, nonetheless we think the debt level is within control.

- We prefer the ANVAU 4.400% 16Aug2027 Corp (AUD) for its shorter duration and a yield of 5.42%. For investors with an appetite for longer duration, both ANVAU 2.600% 31Jul2029 Corp (AUD) and ANVAU 2.2075% 07Aug2030 Corp (AUD) are decent as well.

Background

Ausnet is an Australia company in the energy delivery services business. The group owns and operates more than $12 billion of electricity transmission and distribution networks as well as gas distribution assets. Currently, Ausnet is owned by Brookfield Asset Management after being taken private in February 2022. Co-investors in the acquisition include pension funds in Australia and Canada.

Electricity services segment constitutes the largest share of total revenue

The bulk of Ausnet’s revenue is derived from electricity services segment (electricity distribution: 48%, electricity transmission: 29%), constituting 77% of total revenue in FY23. This is followed by development & future networks at 12% and gas distribution segment at 11%. Development & future networks is the area where Ausnet primarily helps to connect data centres, solar farms, wind farms, energy storage to the grid. 

Chart 1: Breakdown of Ausnet's total revenue 

The path of electricity power: an overview

Getting electricity to your home is quite a journey.

1) Generation: Electricity is generated from various sources like coal, solar, hydro and natural gas

2) Transmission: The generated electricity enters the transmission networks, where it is converted to high voltages to facilitate efficient long-distance travel through transmission lines

3) Substation voltage reduction: The high-voltage electricity is stepped down to lower levels before entering the distribution network

4) Distribution: The distribution network, comprising poles and wires in the streets transports the lower voltage electricity to residential houses and businesses

5) Retailing: Electricity retailers serve as the contact for end users, managing billing and customer service

For Ausnet, they are in the frame from stage 2 to stage 4. Ausnet receive their fair share of profit by transporting the electricity through their transmission and distribution networks. The transmission and distribution fee will be paid by electricity retailers and pass-on to end consumers by forming part of their overall electricity expenses bill.

Serving the residents in Victoria, Australia

Notably, Ausnet is the sole electricity transmission company in Victoria, Australia. However, this does not mean full discretionary in pricing as the Australian Energy Regulator (AER) regulates the pricing Ausnet may charge.

Other than that, in Victoria, there are 5 licensed electricity distributors, namely Ausnet, CitiPower, Jemena, Powercor and United Energy and each of them is responsible for a separate geographical area of Victoria. Comparatively, Ausnet has the second largest customer base in Victoria (around 796 thousand) and possess the biggest distribution regulatory asset base (AUD4.8 billion).

The group also serves gas distribution services to customers in western Victoria and western Melbourne.

Highly regulated business

Ausnet, as a provider of essential services, operates in a highly regulated environment overseen by regulatory bodies. To give an idea, approximately 89% of Ausnet’s total revenue is regulated which is subject to periodic pricing resets by the AER.

The beauty of a regulated business is that while it limit windfall profits, it still enables company to earn a fair profit margin. This creates a stable profit trend, balancing the interests of consumers and the company.

Regulated revenue system ensures that Ausnet can recover its investment while earning a reasonable return on capital

For Ausnet, regulated asset base (RAB) is used to calculate a basis for its revenue. Components of RAB include initial valuation of the infrastructures and additional capex in maintaining the infrastructures, minus any depreciation and any disposal. The RAB is then accounted for inflation and other components like operating expenditures and tax allowance to derive Ausnet’s annual revenue basis. This formulation is applied to both the electricity services segment and gas distribution segment, ensuring a revenue that keep pace with inflation.

Relatively stable operating margin

The consistency in profit is corroborated by Ausnet’s operating margin which is in the north of 30% in the last 5 years. Pretax profit margin has some slight deviation between the years due to different weights in finance costs, nonetheless it has stayed above 14% which is decent.

Finance cost remains heavy due to the investments and projects Ausnet is taking on in the development & future networks segment, resulting in a moderate but still acceptable interest coverage ratio at 1.65 times in FY23. Operating cash flow to finance cost came in at 1.96 times in FY23 which is okay but not the healthiest level we hoped for. But the bright side is that approximately 95% of its debt is fixed rate which minimises the exposure to interest rate risk. We opine that the finance cost is reined.

Table 1: Ausnet’s profit indicators

Table 2: Selected credit profile indicators