Aggressive Portfolio holding Spark Infrastructure Group raised eyebrows last month when it held off on issuing 2015 financial guidance. But management made the move for a practical reason: It’s waiting to hear more on upcoming “regulatory resets” that will determine how much the electricity distributor can collect from consumers each year for the next five years.

Even so, the market didn’t take the announcement well. Spark’s shares have sold off by about 3% on the Australian Securities Exchange since the news broke February 23. That’s despite the company’s hiking its distribution by 4.5% in 2014 and it forecasting another 4.3% increase this year. What’s more, the stock yields more than 5% and trades at just 14 times forward earnings.

For those reasons, plus its collection of solid power-distribution assets, we’ve made Spark one of our two best buys for new money this month.

Generating Income

Spark’s (ASX: SKI, OTC: SFDPF) holdings include 49% interests in two firms that control three electricity distributors: 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.

Also, Spark has built a 14% interest in AE Conservative Portfolio holding DUET Group (ASX: DUE, OTC: DUETF), a move that helped lift its 2014 earnings (more on DUET below).

Spark’s assets rank among the most efficient businesses of their kind in Australia, and they’re known for industry-leading standards of customer service, reliability and workplace safety.

The company brings the same pragmatic approach to its distribution policy, offering the highest level of coverage by free cash flow among its peers, at about 2.0 times. Spark’s current distribution and forecast payout growth are well supported by its earnings and operating cash flow per share.

In 2014, the company’s underlying profit rose 24.1%, to AUD272.1 million. Earnings before interest, taxation, depreciation and amortization (EBITDA) were up 6.1%, to AUD1.489 billion.

Total regulated revenue gained 6.8%, to AUD1.879 billion, while operating costs rose just 2.6%.

SA Power’s revenue rose on a 10% price increase that took effect in July 2014, more than offsetting a 2.7% decline in electricity volumes. Victoria Power’s volumes fell 4.5%.

Operating cash flow per share gained 12.4%, to AUD0.251, providing ample distribution coverage. Spark declared a final distribution of AUD0.0575 a share, taking the full-year payout to AUD0.115, a 4.5% increase over 2013.

Management forecasts a distribution of AUD0.12 for 2015, up 4.3% from last year.

Starting a DUET

In May 2014, Spark announced that it had acquired its 14% stake in Duet Group for AUD402 million. The company made the investment via a derivative contract with Deutsche Bank. 

DUET owns stakes in assets including the Dampier-to-Bunbury Pipeline (Western Australia’s main gas line), as well as Multinet Gas and United Energy, which distribute gas and electricity, respectively, in the state of Victoria.

To cover part of the cost, Spark raised AUD195.8 million from investors and booked an AUD22.7-million unrealized gain on the derivative contracts used to acquire the DUET stake.

Managing director Rick Francis noted that the company invested in DUET to increase Spark’s scale and make it a more attractive investment. He also noted that the interest gives Spark an advantage if the industry attracts further interest from overseas investors.

Spark says it isn’t planning a full takeover bid for DUET. “We are very happy with our holding and would rather have a seat at the table than see the business go offshore,” said Francis.

Rate Regime Favors Spark

In the company’s latest earnings release, Francis also noted that Spark will provide longer-term guidance for distribution growth once it has some clarity about the outcomes of the looming regulatory resets for its companies.

The regulated asset base (RAB) of Spark’s companies grew 4.8% in 2014, to AUD9.03 billion, of which the firm’s share was AUD4.42 billion. Since 2010, the RAB has posted a compound annual growth rate of 7.6%.

The growth of Spark’s RAB over the next five years hinges on the upcoming reset—but it enters the process in a strong position. For one, the Australian regulatory regime is mostly incentive-based and provides rewards for beating certain targets. That’s a plus for Spark, because its companies consistently outshine their peers. In addition, the regime generally supports investment, with a range of built-in protections. Notably, revenues and the RAB are inflation-protected, with allowances for passing operating and debt costs on to customers.

In a key victory, the Australian Energy Regulator (AER) has also proposed a revenue cap for the 2015-to-2020 period for electricity-network operators in its jurisdiction. Revenue cap tariffs reduce weather-related fluctuations in energy demand and remove forecasting risk altogether.

The next regulatory periods start on July 1, 2015, for SA Power Networks and on Jan. 1, 2016, for Victoria Power Networks, including CitiPower and Powercor.

Spark Infrastructure is a buy on the ASX using the symbol
SKI and on the U.S. OTC market using the symbol SFDPF under USD1.80.