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Do Not Expect Any Surprise with Hydro One Limited 2016.Q3 Results

November 12, 2016

By Gulshan Malhotra

During Q3, six major events happened which can impact Hydro One (HRNNF). Out of the six events, two were related to acquisitions, three were related to senior management change and remaining one event was related to storm cause outage to the customers.

Figure 1: Chronology of events for Hydro One during 2016.Q3

Figure 1: Chronology of events for Hydro One during 2016.Q3

Let’s analyze the impact of these events on Hydro One’s 2016.Q4 results.

Acquisitions: Hydro one acquired Orillia Power and also completed the process with regulator to acquire Great Lake Power Electricity (GLPE).

Orillia Power: Orillia power is owned by the City of Orillia, which is in the business of electricity distribution within the municipal boundary of Orillia, Ontario. Orillia was paid $26 million in cash by Hydro One and assumed debt and regulatory liabilities of $15 million. The price is more than twice its book value. In addition, Hydro one committed to decrease of 1% rates to its customers from year 1 to year 5. And also, the rates will increase less than the inflation for the period of year 6 to year 10. It also guaranteed in year 11 onwards sharing of $3.4 million through ESM (earning sharing mechanism).
Precisely, In short, the premium paid for the acquisition is more than 100% with cap on growth in funding for next 10 years. This cost will be recovered through synergy.

GLPE: GLPE is in the transmission business that connects northern Ontario with southern Ontario. Hydro One paid $222 to purchase GLPE. Further, rebasing will happen after ten years in Jan 01, 2027. As per the 2013 financial statements, Equity of GLPE is $110.35 millions. ESM (50:50) is offered during the last five years of deferral period where earnings are above 300 basis point. In short, premium paid in this acquisition is more 100% of the book value.
Both the acquisitions carry high premium with no growth for 10-15 years which is considered significantly a long period. This will have a negative impact on ROE in the long term. Moreover, the impact of these acquisitions, will not be visible in 2016.Q4. Even in future the impact will not be visible since both the acquisitions are so small in size as compared to Hydro one equity of 9,759 million in 2015.
Change in senior management: I will consider these changes quite favourable to the organization. The changes made by the organization is generally to achieve a higher target, increase integration between different departments and become more profitable than present. The impact of change in management will not be visible in short term.

Storm: According to another news, 73,000 customers were knocked out due to storm. This was unpredictable and carried high costs. The additional costs due to storm would have an unfavourable impact on financial scenario and will be visible in Q4.2016 reporting.

Weather: Hydro One business has high correlation with the weather. The weather in Ontario during Q3.2015 was not extreme. So there should not be any impact on financial compared to prior period

In the above discussion, it is expected that Hydro One results should be slightly below than anticipated and prior period.

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