The Province of Ontario is in the process of making 60% of the public utility Hydro One available via an IPO for public investment. Hydro One, which is currently a Crown Corporation owned wholly by the government, is being sold to public investors to raise money for Ontario. Since this is the most interesting thing I’ve heard of coming out of the Canadian stock markets in awhile, I figured a look through the prospectus was in order. Here are some of the very basic financial highlights from the prospectus.
Business History & Overview
The Province of Ontario is the largest and richest province in all of Canada around 13.5 million and GDP of slightly under $700 billion. Canada’s largest city, Toronto, is located here alongside the seat of government. Imagine a combining Washington, DC and New York City into one state.
The basic configuration of a typical electricity system involves:
- Electricity Generation
Hydro One is in the business of transmitting and distributing electricity in Ontario. You may be wondering who actually generates the electricity. Hydro One is not, I repeat not, in the business of actually generating electricity.
Electricity generation in Ontario is split between public and private corporations. Ontario Power Generation, a public company wholly owned by the Province of Ontario, generates approximately 50% of all electricity in the province. The rest of the electricity is produced by private corporations. If you care to know who these smaller players are, here is a list of licensed electricity generators in Ontario provided by the Ontario Energy Board.
A little bit of history for those of you interested: Hydro One and Ontario Power Generation, along with the Independent Electricity System Operator, Electrical Safety Authority, and the Ontario Electricity Financial Corporation, all used to be under the crown corporate umbrella of Ontario Hydro. 1998 was when Ontario Hydro was broken up into these 5 separate entities following the Energy Competition Act of 1998. This act was legislated mainly to promote low-cost energy through competition.
Since Hydro One does not generate electricity, let’s take a visual look at their business model:
Hydro One’s transmission system accounts for 96% of Ontario’s electricity transmission network. Suffice to say, Hydro One has a monopoly on the electricity transmission network in Ontario.
Distribution, on the other hand, focuses on systems that deliver electricity over low voltage power lines to customers. Ontario has 72 local distribution companies that provide electricity to approximately 5 million customers. The largest 15 distribution companies account for about 78% of the 5 million customers.
Hydro One is the largest of these 15 largest distribution companies, with approximately 1.2 million customers, representing about 24% of the total customers in Ontario:
An interesting note from page 7 was the following:
To create more efficiencies in the distribution sector, the Premier’s Advisory Council on Government Assets has endorsed the need for faster consolidation among local distribution companies in Ontario. The Province has responded by announcing tax incentives in the 2015 Ontario Budget which are intended to promote consolidation.
Speculating here, but I wonder which large energy utility would most likely be gobbling up smaller players in this bid for consolidation?
Basic Financial Highlights
From the Income Statement:
- 2014 Revenue of $6.5 billion
- 2014 Net Income of $747 million.
- 10 year Net Income CAGR of 4.1%
From the Balance Sheet:
- 2014 Total Assets of $22.5 billion
- 2014 Total Liabilities of $8.9 billion
From the Statement of Cash Flows:
- Cash Flow from Operations of $1.2 billion in 2014
- 10 year Cash Flow from Operations CAGR of 3.3%
- CapEx for the previous 5 years of ~$1.5 billion per year.
- CapEx projected for the next 5 years at~$1.5 billion per year.
Other things that caught my eye:
- Intends to enact a DRIP
- Annual dividend payout is anticipated to be ~$500 million initially, with a payout target of 70%-80% of net income.
- No one but the Province of Ontario can hold more than 10% of any class or series of Voting Shares.
- Consistent ROE of ~8-10% per year.
This offering is interesting as you get an opportunity to take an ownership stake in what is essentially the monopoly electricity transmission and distribution company in the largest and most important province in Canada. It doesn’t take a genius to see that energy is an essential commodity of modern life, and the companies who own and operate the lines that deliver this essential commodity will make good profit for decades to come.
However, without any details on how many shares will be outstanding and what the price of ownership will be, it is difficult to come to any conclusion on whether ownership in Hydro One is a good deal. Like I’ve highlight in the past using a rental condo as an example, the returns you will experience from an asset are fundamentally based on the price you pay for it.
Hydro One, while an enticing investment prospect, is still missing important data to come to any reasonable conclusions on what fair value is. You cannot even perform a basic discount cash flow analysis as we are still missing those all important figures of how many slices of ownership will be created and what the price of each slice of ownership will be.
So until then, just rummage through the multi-hundred page prospectus and learn what you can about the business if you are interested in potentially taking ownership in this Canadian public utility in the future.