The surge in power prices is a big issue for the federal government, but it is also shaping up to be one of the most important themes this reporting season as companies grapple with its impact on earnings.
Household power bills have steadily risen in recent years and the introduction of a new pricing structure on July 1 has increased prices sharply. Consumers’ power bills along the east coast and in South Australia, who account for 88 per cent of the population, are estimated to rise 15 to 20 per cent this financial year.
Australians pay among the highest electricity prices in the world. We believe this is primarily due to a failure of state and federal energy policy over the past decade, which has increased generation and distribution costs.
With polls showing energy prices are among the electorate’s biggest concerns, Prime Minister Malcolm Turnbull is motivated to take action to reduce voters’ power bills and has hinted the government may use regulation to put downward pressure on energy prices.
As energy is a complex industry, with pricing influenced by a range of variables, including the amount spent on infrastructure, consumer demand and state and federal regulations, the government faces a big challenge to reform power pricing.
Coping with the challenge
While Mr Turnbull and Energy Minister Josh Frydenberg work through potential policy solutions, many ASX-listed companies are dealing with the implications of increased power prices to their bottom lines.
Rising power prices create an obvious problem for companies in the energy-intensive manufacturing industry, such as plastics maker Pact Group and chicken processor Inghams Group. Resources companies are similarly exposed, particularly businesses with refining and smelting operations and underground mines.
With energy costs typically their greatest business expense, data centres are also facing adverse effects from higher power bills. However, Citi analysis notes increasing energy prices may deliver them a benefit in the medium-term as more businesses look to outsource this energy-intensive aspect of their operations.
On the other hand, utility companies are poised to benefit, given higher power tariffs boost revenues. Energy retailers may face their own trouble as they balance the competing demands of increasing profitability, while improving energy affordability in an uncertain policy environment.
We anticipate many households will experience “bill shock” over the next three to six months. If customers respond by seeking out more competitive power plans, another potential beneficiary is the ASX-listed comparison website, iSelect.
We are particularly focused on outlook commentary regarding forecast power expenses and how increased costs can be recouped. In most instances we expect price rises will be passed on to customers, although there are exceptions.
A company’s ability to recoup additional power costs may hinge on the use of contractual provisions that allow these expenses to be passed through to customers, and on their competitive environment. For example, companies are unlikely to increase their prices if they have offshore competitors unburdened by higher Australian power prices.
WA offers big advantage
Other factors to look for include the use of hedging contracts which may see lower power prices locked-in for extended periods delaying the effects of power price hikes. The location of a company’s operations is also material with overseas energy power prices often comparatively lower than Australia’s.
Companies with Western Australian-based operations are also less exposed as the state’s energy costs are considerably lower than the eastern and southern states, which are part of the national electricity market.
This reporting season we are also looking for company initiatives to meet electricity requirements by using alternative sources and other cost-saving programs to help mitigate the effects of higher energy costs.
Among the companies that have already reported, SCA Property Group predicts its power bill will surge by about 30 per cent (or $1.8 million) a year across its shopping centre properties. However, the company expects about two thirds of forecast power cost increases will be passed through to its tenants. The company also has plans to offset forecast increases by installing solar panels and low-energy lighting.
Power price hikes have the potential to affect a large number of ASX-listed companies.
As investors we are focused on the factors that can influence this proportionally large input cost and identifying individual companies’ level of exposure. We then consider how companies in our portfolio are positioned to offset higher power costs, including through contractual provisions to pass on power price increases.
Chris Stott is chief investment officer of Wilson Asset Management. Entities managed by Wilson Asset Management own shares in iSelect.
Great article Chris, a very interesting dynamic to keep an eye on.