AE Portfolio Aggressive Holding Spark Infrastructure Group (ASX: SKI, OTC: SFDPF) closed at AUD1.82 on the Australian Securities Exchange (ASX) on Feb. 25, 2014, having surged from a Dec. 10, 2013, 12-month closing low of AUD1.54 despite a challenging demand environment and rising interest rates and bond yields.

By mid-March the stock was trading around AUD1.66 on the ASX, laid low after management reported a 26 percent decline in statutory net profit after tax (NPAT) for 2013 to AUD128.4 million, as the company absorbed a AUD16.2 million settlement with the Australian Tax Office (ATO) and a higher tax bill from deductions that have now been disallowed.

In January 2014 management announced the resolution of one of the matters under ATO audit pertaining to SA Power Networks, the deduction of rental installments on the 200-year lease arrangements applicable to that business.

The ATO agreed to the preservation of all deductions already made (up to Dec. 31, 2012), but Spark won’t claim any further deductions in respect of the matter. Spark therefore reported a one-off non-cash tax expense for 2013 of AUD16 million.

But no cash payment is due to the ATO, and there will be no further adjustments relating to this matter in future.

This outcome is not material to the business, and there are several other matters that remain unresolved. But management is encouraged by the progress evidenced here as well as by the fact meaningful discussions with the ATO can lead to mutually acceptable conclusions.

The impact of the ATO dispute is well reflected in Spark’s share price. The current yield of 6.5 percent is ample compensation for investors as the market revalues it based on its solid assets, cash flow generation and distribution growth.

Earnings before interest on loan notes for 2013 rose 6.3 percent AUD294.5 million, below the consensus forecast of AUD321 million due to lower-than-expected returns from its South Australian business.

Electricity sales volumes fell 1.9 percent in South Australia and 1.7 percent in Victoria.

But total revenue rose 8.9 percent to AUD2.1 billion, as Spark continues to benefit from rising regulatory tariffs. Citipower and Powercor tariffs rose approximately 8.9 percent and 8.4 percent, respectively, on Jan. 1, 2013, while SA Power Networks tariffs rose 9.7 percent on July 1, 2013.

Operating cashflow was up 6.1 percent to AUD189.3 million, while earnings before interest, taxation, depreciation and amortization (EBITDA) were up 8 percent to AUD1.403 billion.

Victoria Power Networks delivered revenue growth of 14.9 percent and EBITDA growth of 14.1 percent, driven by higher regulated tariffs and growth in unregulated revenue. The margin-based Powercor Network Services (PNS) business saw increased activity, which in addition to boosting revenues also contributed to a 17.2 percent rise in operating costs.

SA Power Networks showed solid growth in total revenue of 2.8 percent and corresponding growth in EBITDA of 2.4 percent. Operating costs rose 3.6 percent, due primarily to an increase in labor costs, consisting largely of an increase due to a change in accounting for employee benefits.

As of Dec. 31, 2013, the asset companies’ gearing level as measured by net debt-to-regulated asset base (RAB) was 78.5 percent, down from 79.7 percent as of Dec. 31, 2012. SA Power and Victoria Power remain on track to de-lever to around 75 percent net debt-to-RAB by the end of 2015.

Most of the de-levering will happen during at the latter end of the current regulatory period as the rate of capital expenditure growth slows and revenues increase from cumulative tariff increases.

As of Dec, 31, 2013, Spark has reduced its drawn debt levels to zero. Management recently announced extended  and  increased  bilateral  corporate debt facilities, with two  new  three-year  facilities  of  AUD75  million and  AUD50  million,  expiring  in  March  2017, executed with Commonwealth Bank of Australia Ltd (ASX: CBA, OTC: CBAUF, ADR: CMWAY) and Bank of Tokyo-Mitsubishi UFJ Ltd, respectively.

The current undrawn facilities of AUD75 million each with Westpac Banking Corp (ASX: WBC, NYSE: WBK) and National Australia Bank Ltd (ASX: NAB, OTC: NAUBF, ADR: NABZY) have been extended by a further year to March 2016.

Based on its current Moody’s rating of Baa1, Spark will pay an average of 130 basis points above the applicable bank bill swap rate.

The key catalyst on the horizon for Spark is the resolution of its dispute with the ATO over the deductibility of subordinated debt interest payments and other items. The uncertain outcome is, however, well reflected in the current share price.

Management was unable to provide any further clarity on the ATO matters, for fear of prejudicial repercussions, thought it did note that tax matters were of the “highest priority” for the business and that productive discussions were “ongoing in relation to all matters.” A decision on the level of subordinated debt interest will come through later in 2014.

The final dividend in respect of 2013 of AUD0.055 represents an increase of 4.8 percent compared to the final dividend for 2012 and is in line with management’s long-term guidance for payout growth.

Management guided to a 2014 full-year distribution of AUD0.115 per share, an increase of 4.5 percent over the full-year distribution for 2013 of AUD0.11.

And it reaffirmed distribution growth guidance of 3 percent to 5 percent for 2015, with a target payout ratio of approximately 80 percent of standalone operational cashflows.

Spark maintains a relatively conservative distribution policy and the highest level of distribution coverage among its Australian network service provider peers at approximately 2.0 times. The distribution and management’s forecast payout growth are well supported by underlying asset earnings and operating cash flow per share.

Spark’s current portfolio includes 49 percent interests in two entities that control three power companies: SA Power Networks, the South Australia-focused unit formerly known as ETSA Utilities, and Victoria Power Networks, the holding company for CitiPower and Powercor Australia that recently changed its name from CHEDHA Holdings Ltd.

Spark’s 49 percent interest in SA Power and Victoria Power represent an estimated AUD4.2 billion of RAB as of Dec. 31, 2013. Overall RAB for the asset companies grew by 6.6 percent during 2013 to AUD8.6 billion. Management forecast 7 percent to 8 percent annual growth through 2015.

Its assets rank among the most efficient businesses of their kind in Australia, and they have successfully maintained industry-leading standards of customer service, reliability and workplace safety. Spark is in good position as it begins to develop regulatory submissions to the AER.

The Australian regulatory regime is for the most part incentive-based and provides a range of rewards for outperformance against regulatory targets. This system is of significant benefit to Spark’s companies, which operate at the upper end of performance relative to their peers.

The regime generally supports investment, with a range of in-built protections for investors. Notably, revenues and the Regulatory Asset Base continue to be inflation-protected, with pass-throughs for operating and debt costs.

The next regulatory periods commence on July 1, 2015, for SA Power Networks and on Jan. 1, 2016, for Victoria Power Networks, including CitiPower and Powercor. SA Power will make its initial submission to the AER in October 2014, while CitiPower’s and Powercor’s submissions will follow in April 2015.

In a key victory for Spark’s South Australia business, the Australian Energy Regulator (AER) has proposed a revenue cap for the 2015-to-2020 regulatory period. Revenue cap tariffs reduce weather- related volatility to energy demand and remove forecasting risk altogether.

Management noted that its Victoria business is “likely to follow the same path,” confirmation of which would provide a significant boost in the lead-up to the next regulatory reset in 2016.

The expected move from the existing price cap to a revenue cap form of revenue recovery will remove any impact of volume fluctuations in the future.

Spark Infrastructure trades on the ASX under the symbol SKI and on the US over-the-counter (OTC) market under the symbol SFDPF.

Spark Infrastructure, a new addition to the AE Portfolio Aggressive Holdings, is a buy on the ASX using the symbol SKI and on the US OTC market using the symbol SFDPF under USD1.80.

Spark Infrastructure closed at AUD1.70 on the ASX on April 8, 2014, equivalent to AUD1.59 based on the prevailing Australian dollar-US dollar exchange rate.

Spark Infrastructure’s financial year runs from Jan. 1 to Dec. 31. It reports full financial and operating results twice a year; it typically posts first-half results in late August, with full-year numbers out in late February. It will report results for the first half of 2014 on or about Aug. 25, 2014.

Interim dividends are typically declared several weeks ahead of management’s report on first-half results. Final dividends are usually declared in January, though the specific amount of the payment is announced along with full-year results.

Spark’s most recent interim dividend of AUD0.055 per share was paid Sept. 13, 2013, to shareholders of record on Sept. 4, 2013. Shares traded “ex-dividend” as of Aug. 29, 2013.

The final dividend in respect of 2013–AUD0.55 per share–was paid March 14, 2014, to shareholders of record on March 5, 2014. The “ex-dividend” date for this payment was Feb. 27, 2014.

Eight analysts that cover Spark rate the stock a “buy,” while six rate it “hold.” There are no “sell” recommendations on the stock.

The average 12-month target price between the 11 analysts that provide a figure is AUD1.86, with a high of AUD2.10 and a low of AUD1.70.  Based on a April 8, 2014, closing price of AUD1.70 on the ASX, the implied one-year total return, including the present annualized dividend rate of AUD0.11 per share, is 15.9 percent.

Dividends paid by Spark Infrastructure are “qualified” for US tax purposes. Based on the “fiscal cliff” compromise reached in Washington, DC, in early January 2013 dividends will be taxed at Bush-era rates of 5 percent to 15 percent for investors’ first USD450,000 a year of income for couples and USD400,000 for single filers. Above that the maximum tax rate is 20 percent.