Contact Energy - considered a "safe" defensive stock in troubled markets - has delivered a shock, almost 25%, profit downgrade after low winter lake levels forced it to purchase expensive spot market electricity, estimated to have cost $40 million to $50 million.
Contact, which signalled last year that profit would be flat, announces its multimillion-dollar downgrade as the southern hydro lakes of Roxburgh and Clyde are at their highest levels in 10 years and generators are having to spill water.
Contact's shares were pummelled by investors and by midday yesterday were down almost 10%.
By close of trading at 5pm they were down 9.39%, losing 69c at $6.66.
Trading was the heaviest volume in six months, at 978,500 shares traded for $6.5 million.
The shares of its Australian majority shareholder also traded down.
In August, Contact had to sell power to lower South Island customers at a loss, because of the drought, which brought low lake levels.
Also, "significant transmission constraints" across Cook Strait had limited the delivery of lower-priced North Island electricity, according to Contact's chief executive David Baldwin.
He said Contact's underlying earnings after tax are expected to be about 20%-23% less than the last financial year; a drop of up to $53.54 million, down to $179.26 million.
"The current financial year is somewhat unique in that New Zealand's hydro system has experienced two extremes of hydrology within six months, each at opposite ends of the scale," Mr Baldwin said.
Research by brokers ABN Amro Craigs said the winter's first quarter had been "disastrous", with Contact having been "caught short" and forced to buy electricity for South Island consumers at "very high spot rates", and also absorb higher, unexpected gas costs.
"Significantly for Contact, the first four months marked a period of very high volatility, and the company was unable to meet demand in the South Island from its own generation, requiring it to buy on market to meet demand," ABN research said.
Despite the downgrade, ABN broker Peter McIntyre continued to recommend Contact stock as a "standout opportunity" for investors seeking a blue chip, defensive stock, with its own power generation being linked to rising electricity prices.
"It offers excellent value at the current price, reflecting a more than 30% discount to our 12-month target price of $9.46," Mr McIntyre said yesterday.
When asked about the acknowledged defensive stock delivering such a large downgrade, he said the "real surprise" behind the downgrade was Contact being locked into gas supply (for generation) contracts, which had "copped" large increases recently.
"It was unlikely Contact would ever have met last year's net profit after tax, and it has to be remembered it is at the mercy of the elements, with lakes full or half-full," Mr McIntyre said.
He noted Contact's major 51.4% shareholder, Australian-listed Origin Energy, was similarly punished by its shareholders yesterday, and its price shed 5% of value, to trade about $A14.35 ($NZ17.80).
On the question of gas supply charges, Mr Baldwin said recent price increases were "significantly higher than expected" and would contribute to Contact paying about 25% more per gigajoule for gas in the 2009 financial year.
"During the six months ended 31 December 2008, there were two significant increases in the quarterly PPI [producer price index], leading to an annualised increase in PPI to 30 September 2008 of 13.6%.
The PPI movement is applied to adjust gas prices in most of Contact's gas purchase contracts," Mr Baldwin said.
Combining with last year's severe drought conditions were transmission constraints, particularly from the unexpected removal of pole one of the inter-island HVDC link, in November 2007.
These factors would have a negative impact on earnings for this financial year.
The drought and transmission issues limited delivery of lower-priced electricity from the North Island to the South Island, he said.
"This resulted in Contact selling electricity to its lower North Island and South Island customers at a loss during the winter period," Mr Baldwin said.
Transmission issues also affected the flow of Contact electricity during the first half of the financial year.
It subsequently generated 274 gigawatt hours fewer than the same period last year.
The spillage from the southern hydro lakes came from the unexpected and continued reduction in electricity use by the Tiwai Point aluminium smelter, exacerbated by the Cook Strait transmission problem.
"In this situation, [it] limited the volume of lower priced electricity that can be transferred from the southern hydro systems to the North Island," Mr Baldwin said.
Lower aluminium production meant up to 180 megawatts of hydroelectric power were not used at Tiwai; and these were unable to find a transmission path due to transmission constraints.
"We expect the loss of pole one will continue to result in constraints between the islands, and therefore volatility in wholesale prices, as well as increased risk of wholesale price separation between the North and South Islands.
"Until pole one is replaced, and other transmission constraints are resolved, the wholesale electricity market will continue to be impacted during periods of very high and very low hydro inflows, Mr Baldwin said.
Mr Baldwin was upbeat about Contact being well placed to continue with its growth strategy, despite yesterday's downgrade.
Construction is under way on the first phase of the Tauhara geothermal power project near Taupo and the new gas-fired peaking station at Stratford.
Last month Contact started injecting natural gas into its new Ahuroa reservoir, which, when fully developed in 2010, will be New Zealand's first underground gas storage facility.
Mr Baldwin also highlighted "excellent progress" was being made on the engineering and design of the 220MW Te Mihi geothermal power project.
