Michael Newbold from the manager of the TAMIM Australian Equity Growth IMA reviews the investment case for the DUET Group. With continued worries about the sustainability of the Banks dividends, this stock may be worthy of a better look. It offers a best in utility sector yield of 8.3% unfranked.

Investment view

• DUET Group (DUE) is an owner of utility assets in Australia, the US and Europe. DUE owns controlling stakes in three regulated energy utility assets across Western Australia (Dampier to Bunbury Pipeline) and Victoria (United Energy, Multinet Gas), 100% of a pipeline developer (DBP Development Group) and 100% of a Remote Energy and Clean Energy power generator (Energy Developments, EDL).
• Since listing in 2004, DUE has evolved from being an externally managed asset owner/ investment fund to an internally managed asset owner/operator with an EV of over A$18bn.

• DUE has been evolving its business over recent periods, focusing on lowering its exposure to regulated revenues and looking for more growth opportunities.  While the recent EDL acquisition arguably increased the pure financial risk profile for DUE, it diversified the earnings base away from the regulated earnings stream which is likely to be pressured from future regulatory resets.
• Additionally, the acquisition provides an avenue for growth which was likely to be limited to the DBP Development Group business given the unlikely need for an expansion of the Dampier to Bunbury pipeline in the short term and ongoing pressure on electricity and gas networks to cut capex and lower costs to consumers.
• DUE trades on an unchallenging 11.7x FY17 EV/EBITDA and offers a best in utility sector 8.3% unfranked yield with minimum expected growth of 2.7% pa through FY18. With Management executing on transactions well and finding growth in a tough market, we continue to see a solid outlook for the business.

Recent transaction

• DUE recently raised A$230m to fund the acquisition of the remaining 20% of theDampier to Bunbury Pipeline (DBP) that it didn’t already own.
• The DBP, located in Western Australia, consists of c1539km of mainline pipe, 1228km of loop pipe and 300km of lateral pipe. It has 10 compressor station sites with a total of 27 compressor units and a full haul capacity of 845 TJ/day. The pipeline is expected to be in service for at least the next 50 years. Almost all of DBP’s revenue is derived from contracted gas transportation tariffs, charged to wholesale customers for shipping gas along the Pipeline
• The acquisition price implied 10.5x CY15 EBITDA and 0.94x Regulated Asset Base (RAB, Dec 2015). Regulated assets such as the DBP generally trade at a multiple of their RAB of between 1.2-1.5x and recently transactions in the space have been priced at in excess of 1.6x RAB (Transgrid recently transacted at 1.64x its RAB). However, given DUE’s existing control over the asset, and other specific factors (e.g. information requirements), the vendor was unable to run a competitive process and DUE was able to secure the asset for a very attractive price.
• The transaction was valuation accretive, simplifies the ownership structure and may provide synergies by allowing for a further combining of operations between DBP and the DDG.

Outlook

• While there are some risks around the regulatory outlook for DUE’s networks, these have broadly been factored into the market’s forecasts and Management DPS targets have factored in worst case outcomes from these reviews. Furthermore, growth from EDL and the DBP Development Group should largely offset potential weakness.
• DUE has also made recent announcements updating the market on EDL’s growth projects. These include a new 21MW waste coal mine gas power station at Grosvenor (Anglo American). This was expected and commissioning is due in April 2017. Secondly it will build, own and operate the 4MW Coober Pedy Renewable Hybrid Power Project. Construction to commence in September 2016 with commissioning in 1H FY18. No details were given of capital expenditure or expected returns but we note that these projects will pad out the growth profile for DUE.
• Post transaction, Management has reaffirmed DPS guidance over 2016-2018 of 18cps growing to 19cps. With this transaction adding to cashflow, and recent announcements such as the one detailed above there should be upside pressure to this in FY17 unless management looks to improve free cash flow metrics (which would be positive for valuation in any event).

Catalysts

• Catalysts for share price performance include contract wins in the DDG and EDL business units,
• Better-than-expected outcomes from the DBP regulatory reset and United Energy regulatory reset (final decision due imminently),
• Activity in relation to SKI selling down its stake and
• Potential corporate activity as underbidders in the NSW electricity privatisation process potentially looking to acquire other regulated asset holders.

Happy investing,

​The team at TAMIM.