Genesis Energy broader energy exposure funds higher dividend

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1 Genesis Energy broader energy exposure funds higher dividend We value Genesis, relative to its peers, at the top end of the indicative price range Genesis Energy (GNE) will be floated on 17 April The indicative price range is $1.35-$1.65/sh with one billion shares on issue. We believe that if it was listed today, relative to where its peer set (listed gentailers) are trading, it would be trading near the top end of the indicative range at c. $1.63/sh. We also believe that the peer group is undervalued. Added to this, in our view there is a potential further 10cps upside specific to Genesis due to yearly wholesale volatility as well as the potential to make windfall gains in event of a material dry year weather event. Fuel management key to Genesis success Genesis contracts gas and coal on a take or pay basis from upstream suppliers. It uses the fuel in its electricity generation, gas retail and gas wholesale businesses. Given the inflexible gas contracts, we expect Genesis to continue to run its gas base-load plants at high capacity so as to reduce its loss on its gas book. While this may at times appear to be suboptimal when viewed from an isolated electricity generation standpoint it is, in our view, optimal when the entire group s performance is considered. The take or pay contracts on gas (c. 40 petajoules (PJ)) are c. 12PJ s too much to meet average hydro conditions and we estimate that its net impact on FY14 earnings is c. NZ$20m. We expect this to turn to a positive impact in FY18/19 and is hence a source of earnings growth. Genesis is not well placed to face an overcapacity market that could deteriorate if Tiwai cuts back its load but most of the negative impact from poor historic contracting decisions is already in its current earnings. Dry year and wholesale volatility not incorporated into valuation While in an average hydro year Genesis carries the negative burden of its long gas position, in a materially dry hydro year, it will be well positioned to make extraordinary profits with the extra supply and generation capacity. This is because the rest of the market is exiting most of its ability to substantially peak. Also, model forecasts use average weather expectations, we estimated that the actual fluctuations around this average are worth an extra 10cps to valuation. Be wary of the attractive headline prospectus 9.7% net dividend yield On face value, Genesis offers a very attractive fully imputed FY15 net dividend yield of 9.7% at the top of the indicative price range given a sector average FY15 net dividend yield of 7.0%. However, we point out that this is an oversimplified comparison as a material part of Genesis value stems from its investment in Kupe (owns 31% of JV) which is expected to cease to produce cash post FY26/27. As such, Genesis needs to return a materially higher level of cash relative to its valuation in order to compensate investors for the risk and timing associated with unlocking the value of Kupe before it runs dry. If Genesis was trading at $1.63/sh, it would equate to a FY15 fully imputed net dividend yield of 9.8% and an EV/EBITDA multiple of 7.4x using our forecast EBITDA. Excluding Kupe and reflecting just Genesis gentailer business, its implied FY15 EV/EBITDA multiple of 8.0x would be modestly below the electricity sector average of 8.4x but our forecast EBITDA growth for Genesis over the next five years is slightly behind what we expect from the industry. Biggest risk is political A key risk is the potential for an electricity industry regulatory change. The current NZ political opposition party has intimated that if it wins the next election, then it will revamp the electricity regime which could have a materially negative impact on the existing gentailers earnings. There are a number of other risk factors, including (1) Transmission Pricing Methodology changes, (2) reduced load from Tiwai point, (3) a cheap new generation source, (4) Genesis generation failure. Genesis is a complex business with lots of moving parts, and it faces some risks that are binary in nature the biggest being the outcome of this year s election where a National win implies the status quo, but a Labour/Greens win exposes the sector to potential structural change to returns on hydro generation assets. Our fundamental value range for Genesis is $1.97/share if National was to win the next election and $1.52/share if Labour win. We believe that if it was listed today, based on where its peer group (listed gentailers) is trading, it would be trading near the top end of the indicative range at c.$1.63/ share. We also believe that the peer group is undervalued. Added to this, in our view there is a potential further 10cps upside specific to Genesis due to wholesale price volatility as well as the potential to make windfall gains in event of a material dry year weather event. At face value, Genesis offers a very attractive fully imputed FY15 net dividend yield of 9.7% (13.5% gross yield) at the top of the indicative price range, compared with the sector average FY15 net dividend yield of 7.0%. However, we point out that this is an oversimplified comparison as a material part of Genesis cashflow and value stems from its investment in Kupe (Genesis owns 31% of the Kupe JV) which is expected to cease producing cash post FY26/27. As such, Genesis needs to return a materially higher level of cash relative to its valuation in order to compensate investors for the risk and timing associated with unlocking the value of Kupe before it runs dry. If Genesis was trading at $1.63/share, it would equate to an FY15 fully imputed net dividend yield of 9.8% and an EV/EBITDA multiple of 7.4x using our forecast EBITDA. If we exclude the Kupe stake (and earnings) to consider Genesis gentailer business alone, its implied FY15 EV/EBITDA multiple of 8.0x would be modestly below the electricity sector average of 8.4x but our forecast EBITDA growth for Genesis over the next five years is slightly behind what we expect from the industry. In our view, Genesis represents good value, even at the top of the IPO range ($ $1.65), and we expect the float to be wellreceived by the market. The yield is attractive notwithstanding our earlier comment that it needs to be higher than its peers to reflect the high cashflow and limited life of Kupe. The loyalty bonus for retail shareholders (1 share for every 15 held for 12 months, up to 2000 shares maximum) adds an incremental yield of up to 6.67% in the first year.

2 Valuation summary Genesis Energy (GNE) will be floated on the 17 April The indicative price range is $1.35-$1.65/sh with one billion shares on issue. We believe it should be trading near the top end of the range at $1.63/sh if it was listed and priced relative to other listed NZ gentailers are currently trading. That said, we are of the view that: its fundamental valuation should be higher than a value priced on a relative basis ($1.63/sh) due to our view that the listed NZ electricity sector being currently undervalued, there is potential for 10cps further upside to our fundamental valuation as our earnings forecast is based on a normalised hydrology. If a varying hydrology pattern where modelled instead, Genesis average earnings path would be higher than what we have forecast. We believe Genesis is exposed to a material upside earnings windfall with respect to a material dry year, but limited downside in wet years. This is not modelled. If Genesis was trading at $1.63/sh, it would equate to an FY15 fully imputed net dividend yield of 9.8% and an EV/ EBITDA multiple of 7.4x using our forecast EBITDA. Excluding Kupe and reflecting just Genesis gentailer business, its implied FY15 EV/EBITDA multiple of 8.0x would be below the electricity sector average of 8.4x. Our fundamental value range for Genesis is NZ$1.97/sh if National was to win the next election and $1.52/sh if Labour win. The following chart highlights Genesis upside and downside potential under the two scenarios and compares its fundamental value range against its listed peers. We have adopted $1.63/sh as Genesis hypothetical listed value in the following value comparison. Figure 1: Valuation upside/downside under both regime Note: Share price as of 19 March 2014 *The Meridian up and downside is against the MELCA instalment receipt. On face value, Genesis offers a very attractive fully imputed FY15 net dividend yield of 9.7% (gross yield 13.5%) at the top of the indicative price range given a sector average FY15 net dividend yield of 7.0%. However, we point out that this is an oversimplified comparison as a material part of Genesis cashflow and value stems from its investment in Kupe, which is expected to cease to produce cash post FY27. As such, Genesis needs to return a materially higher level of cash relative to its valuation in order to compensate investors for the risk and timing associated with unlocking the value of Kupe before it runs dry. Genesis dividend policy is broadly to at least grow dividends in real terms. Its policy to grow dividend, in conjunction with its FY15 dividend of 16cps being an estimated 81% of free cash flow, allows us to interpret the policy to mean that Genesis will pay 80% of adjusted free cash flow and a greater percentage if 80% of the cash flow isn t greater than the prior year dividend plus inflation. Genesis capex requirements, like that of its peers, are largely limited to stay in business of maintenance capex for some years the sector is in overcapacity and will not require investment in additional generation plant for a number of years. In our National wins the next election scenario, we expect free cash flow to decline moderately post the prospectus years, before rising again post FY18. We therefore anticipate only inflationary growth on the FY15 dividend through to FY18. This assumed dividend stream will imply a peak 97% payout of FY18 free cash estimates, and is then forecast to decline as a percentage thereafter. Consequently, we see the FY15 dividend as sustainable with modest growth through to the end of Kupe s contribution, and then growth in dividends to be in line with its sector peers. So, while

3 Genesis dividend yield is a high now, we expect it will grow at a slower rate than we anticipate from its peers. The peers are starting at a 7.0% net yield in FY15. By FY26/27, when Kupe is gone, the peers and Genesis yield should have converged, and thereafter we expect Genesis dividends should grow generally in line with its peers. The retail loyalty bonus of 1 share for 15 held from IPO for a year (up to a maximum of 2000 shares) is an attractive additional incentive, with most retail investors effectively receiving a 6.67% added dividend in the first 12 months. Business overview Genesis is in the business of supplying energy to homes, and to a lesser degree to commercial and industrial companies, in the form of electricity and gas. In order to do this it needs generation capability, which uses gas and coal as an input, and gas to supply to the end user. It has thus contracted coal (3 year contract) and gas (6 plus years) in order to facilitate a sustained profit model. The inter-relationship between the quantum of gas contracted and its revenue generating uses is key to the variation in the company s potential earnings. In our view, Genesis gas market operation is intertwined with its core electricity business and it actively manages its fuel source to achieve an optimal outcome for both its gas and electricity operations. Genesis also has a partial ownership in Kupe oil and gas field, which has its own unique earnings profile that is independent of the core electricity business. In our view, Genesis operates three key intertwined business segments including: Integrated NZ electricity generation and retail operations: Genesis generates electricity, sells it into the grid, purchases it back for retailing to its mass market and C&I customers. Retail and wholesale gas operations: Genesis has contracted gas supplies from Kupe and other suppliers, and on-sells it to retail and wholesale customers. A significant proportion of this gas is used for electricity generation. Strategic stake in the Kupe gas field: Genesis owns 31% of the Kupe joint venture and its financial performance is proportionately consolidated into its income statement. Genesis is also contracted to purchase 100% of the Kupe gas output. Genesis group performance and relative performance between its three core business segments is underpinned by the way it manages its fuel supplies. Figure 2: Genesis Value Chain Suppliers Fuel Management Generation Customers Solid Energy (coal) Coal stock pile Gas/coal/hydro/ wind generation Electricity Kupe (gas) Fuel Management Retail gas Other gas suppliers (gas) Wholesale gas

4 Genesis contracts gas and coal on a take or pay basis from upstream suppliers (i.e. it has to pay whether it takes the gas or not). Genesis owns 31% of one of the suppliers, Kupe. Due to the take or pay nature of the fuel contracts the company has to optimise which channel should consume the fuel. The decision is not always easy as sometimes a less than optimal decision is made in one channel, but by making this choice the company mitigates bigger losses elsewhere. The positive of coal in a take or pay environment is that it can be stored easily and cheaply. Generation is the core business and where most of Genesis earnings come from. The retail gas business is profitable and growing in volume terms. The wholesale gas channel loses money as it is where most of the negative impact of the over contracted gas position is absorbed. This is a little unfair as it is also the channel than provides generation with the opportunity to increase output materially and create a windfall gain, if a material dry weather event occurred. Fuel management In FY13 Genesis purchased 38.6PJ of gas from Kupe and other gas fields on a take or pay basis, and used this to meet the needs of its generation plants (FY PJ) and its retail customers (5PJ). The remaining unused gas was sold into the wholesale market (12.6PJ). Genesis takes 100% of the Kupe gas production for the life of the field, which equated to 18.2PJ in FY13 but should average 20PJ p.a. over the life of the field. Genesis also contracts gas from other fields, which amounted to 20.8PJ in FY13. The current contracted volume will step down from FY15 and will expire by the end of CY20. Genesis has purchased long term contracts, which we expect will continue to modestly reduce from FY13 levels through to a sharp fall off by the end of FY20. The gas contracted in excess of its generation and retail needs is sold into the wholesale market at a loss we estimate at c.$1.50/gj given the current contracted and market gas pricing levels. With the non-kupe contracts expected to reduce materially over FY20, we forecast Genesis net long gas position to reduce from it s a peak of 15.7PJ in FY14 to 4.4PJ in FY20. The reduction in long gas position coupled with an improvement in the wholesale gas pricing environment has led us to forecast a loss reduction in Genesis long gas position from a peak loss of $21m in FY14, to a modest profit of $3m in FY18. Genesis is the largest natural gas retailer in NZ with 43.7% market share. It serves c.115,600 gas customers and c.11,000 LPG customers. The wholesale business is an on-seller of the gas from the TOP (take-or-pay) commitments that are in excess of the company s retail and generation needs to customers including other thermal generators, industrial customers and Methanex. The following charts provide our forecast for Genesis gas source and usage: Figure 3: Gas usage Figure 4: Gas source Source: Genesis Energy, Craigs Investment Partners estimates Source: Genesis Energy, Craigs Investment Partners estimates Note: FY21F Non-Kupe contract assumed to meet gas needs at that time. In a nutshell, in FY13, Genesis purchased 39PJ of gas (18.2PJ from Kupe and 20.8PJ from other gas fields) at an average cost of $8.20/GJ. It then sold 5PJ into the retail market for $21.90/GJ and 13.1PJ into wholesale gas market at $6.70/GJ.

5 Figure 5: Wholesale gas contribution Source: Genesis Energy, Craigs Investment Partners Electricity business: Generation, retailing and integrated profitability Genesis has an NZ based integrated electricity generation and retailing business, holding c.20% market share in the generation market and c.27% in the retail market. It sells c.5,500gwh of electricity to both residential and C&I customers and generates c.7,000 GWh of electricity in a normalised year, comprising 60% thermal and 40% renewable generation. With a strong thermal generation fleet and excess capacity, Genesis plays a key role in the contracts market effectively offering dry-year insurance to other market participants to manage volatility in hydro generation and inter-island price separation risks. The electricity business is facing major overcapacity issues as well as political risk. Our forecast for Genesis electricity margin is based on our industry wholesale electricity price path, which we expect to track to $70/MWh (real) by FY18 on Tiwai demand reductions, and recovering thereafter towards the long run marginal cost estimate of $80/MWh (real) over time. While the industry in general is unlikely to get price increases for their component of the electricity bill, Genesis is in a favourable position to be able to put through c.2.2% net increases over both FY14 and FY15 as it brings its electricity prices from below to in line with industry averages. Thereafter we expect limited ability to raise prices through to FY18 when we are anticipating a return to supply-demand balance. We also expect Genesis to continue to build its retail customer base and aggressively acquire C&I customers over the next two years, particularly in the South Island, to better match its generation portfolio geographically. As we are expecting the market to lose 1,500GWh of Tiwai demand from CY16, industry overcapacity to ease in FY17, and an improved environment only in FY18, we expect a sustained period of soft electricity pricing growth and increased competition in the retail space, constraining Genesis ability to grow its retail book from FY Reflecting our industry outlook, we forecast Genesis FY15 electricity margin only to be surpassed in FY20.

6 Overview of Genesis generation assets Genesis has a diversified generation portfolio comprising of hydro, coal and gas generation assets. It operates NZ s only coal generation plant at Huntly and generated c.17% of the national demand or 7,212GWh in FY13. The following table compares Genesis generation portfolio to other major gentailers: Figure 6: Generation supply by the major gentailers (year to June 2013) Capacity (MW) Genesis Meridian CEN MRP TPW Total Genesis s share Hydro 685 2, , , % Thermal 1, , , % Geothermal % Wind % Total 2,142 2,694 2,283 1, , % Volume (GWh) Hydro 2,201 10,918 3,561 3,944 1,287 21, % Thermal 4, , , % Geothermal 0 0 2,249 2, , % Wind 22 1, , % Total 7,213 12,070 9,879 6,461 1,915 37, % Note: One Huntly Rankine unit has been decommissioned while another unit has been put into storage in Dec Each Rankine unit has 250MW capacity. Figure 7: Generation output (GWh) The MW Huntly Power Station is NZ s largest power station by capacity and is capable of providing c.16-18% of NZ s electricity needs. In the last dry year, FY12, Huntly s total output was 5,654GWh, c.13% of the country s output. The Huntly power station operates on both gas and coal and provides both base-load generation and peaking capability, allowing Genesis to take advantage of short-to-medium term price spikes. The original four 250MW units Rankine units at Huntly plant can run off both gas and coal. Genesis removed its first Rankine unit in Dec 2012 and the second Rankine unit in Dec The second unit can be returned to service within 90 days in extreme circumstances. Huntly unit 5 (previously called e3p) is a 403MW base-load CCGT (combined cycle gas turbine) plant commissioned in Huntly unit 6 is a 50.8MW, dual fuel (gas or diesel), peaking OCGT (open cycle gas turbine) plant.

7 Genesis operates three hydro schemes with a combined generation capacity of 679MW. Tongariro and Waikaremoana hydro schemes are based in the North Island, while Tekapo A&B is located in the South Island. The key advantage for North Island (NI) hydro stations stems from their low correlation between wholesale prices and NI hydro storage. This means that NI hydro generators can take advantage of the high wholesale prices when South Island (SI) is dry. The following table summarises our view on the performance of the hydro assets under various hydrological conditions: Figure 8: Genesis generation portfolio North Island South Island Wholesale price Advantage to NI generators vs SI Wet Wet Low N / A Wet Dry High +++ Dry Wet Low - Dry Dry High N / A Genesis 7.3MW 15 turbine Hau Nui Wind Farm was New Zealand s first commercial wind farm and has been operational since Genesis has no generation development intentions over the next three to five years, though it has a number of longer term growth prospects in renewables. Retail Business Genesis is NZ s largest electricity retailer with c.530,000 electricity customer connections, holding 27% share of the retail electricity market. Electricity is sold to two key segments; residential and commercial and industrial (C&I) customers. Residential: Residential customers are domestic households on FPVV (fixed price variable volume) contracts, which allow customers to use as much electricity as they want at a fixed price per unit. This customer segment accounted for 4,902GWh or c.92% of Genesis total sales by volume in FY13. Retailers generally reserve the right to change the price charged under FPVV contracts and consumers can usually terminate their contracts with minimal notice periods. Commercial and Industrial: C&I customers accounted for 452GWh or c.8% of Genesis total sales by volume in FY13. Genesis currently has c.350 C&I customers and is seeking to grow its C&I sales. These customers often pay for their electricity on a Time-Of-Use (TOU) basis, that is, the prices they pay depend on the time at which they consume electricity. Genesis sells electricity, natural gas and LPG to more than 650,000 customer connections through its two retail brands: Genesis Energy, its nationwide brand, serving 473,000 electricity customers, 114,000 natural gas customers, and 10,700 LPG customers; and Energy Online: its no frills brand for customers looking for service at competitive prices, serving 67,300 customers and 1,500 natural gas customers. Genesis has a lower electricity customer switching rate of 18% to December 2013 compared to an industry average of 20%. The company believes its below-sector churn is a result of its competitive pricing, advanced metering enabled services, along with its dual fuel offering. A low churn rate helps to reduce cost and improve margin for Genesis.

8 The Kupe Joint Venture Genesis has a 31% ownership interest in the Kupe oil and gas Joint Venture. It receives 100% of the gas offtake and a 31% share in the crude oil and LPG output. Other partners of the JV include Origin (50%), NZOG (15%) and Mitsui (4%). When extracting the commodities from the ground the extraction process brings up gas, oil and LPG. Currently for every 1PJ of gas extracted, 68kbbl of oil comes up and 4.3Kt of LPG. While LPG production is likely to remain reasonably constant over time in line with gas production, the amount of oil production reduces substantially. The extraction rate is driven by the Genesis gas take which is set at 20PJ per year for the life of the resource. We estimate that the Kupe field will have its last year of production in FY26. Figure 9: Kupe production oil, gas and LPG Source: NZOG and CIP estimates We value Kupe s earnings stream separately from the core Electricity gas business. We assume that there is no gearing and a WACC (weighted average cost of capital) of 10.8% (using market risk premium: 6.5%, beta: 0.90, gearing: 0%), giving a DCF value for Genesis 31% stake in Kupe at $484m.

9 Group earnings outlook In the Prospectus, the company has FY14 and FY15 EBITDA forecasts of NZ$305.2m and NZ$363.4m respectively. The following table highlights our view of how the three divisions will perform over FY14 to FY20 Figure 10: Earnings projections $m Source: Genesis, Craigs Investment Partners We expect earnings similar to the prospectus over FY14 and FY15. However post prospectus we expect Genesis generation volumes to decline as the Tiwai scenario plays out. This negative impact from the overcapacity environment is partially offset by the improving gas book. Kupe, due to the lower quantity of oil that is extracted per year, over time has a diminishing impact on EBITDA. There are expected to be cost reductions as the company moves to optimise the new configuration of Huntly. Already the company has moved 85 staff off Huntly to a centralised office in Hamilton. There are gains to be had from the change in the coal contracts, with particular reference to stock handling. The coal will move more efficiently from supplier to generation without always going to the stock pile. Maintenance around the Rankine units will also be reviewed. While there is little of this in the prospectus forecast, we are expecting normalised costs to reduce in nominal terms through to end FY16. Capex and dividend policy Genesis intention is to pay a consistent, reliable and attractive dividend, with the dollar amount being at least maintained in real terms. We interpret this to mean that it will pay at least 80% of its defined free cash flow and will pay a higher percentage of free cash flow if this does not beat the prior years dividend by inflation. This would take into account dry to wet swings in most cases. The free cash flow calculation is EBITDAF less finance cost, income tax and stay in business capex. Management expects a long-run stay-in-business capex of between $40-$60m, with the prospective period forecast being assumed at the top of this range. The only major lumpy maintenance capex is the $10-15m spend on Unit 5 s (E3P) 50,000hrs refurbishment, which occurred in FY13 and will only be due again in 2017/18. Figure 11: Capex Forecast Source: Genesis Energy Genesis prospectus dividend is for $128m and $160m to be paid in FY14 and FY15. While we expect that the free cash flow will have a near term peak in FY15, and only exceed this in FY19, the policy allows for the dividend to have modest growth through the overcapacity cycle. What we highlight in the above table is the importance of Kupe s contribution to the free cash generation.

10 Figure 12: Dividend Forecast Source: Genesis Energy, Craigs Investment Partners The dividend is intended to be paid semi annually, in April and October each year, split 50:50 between interim and final dividends. At the end of FY13, Genesis had c.$297m of imputation credits remaining. Genesis expects its dividend to be fully imputed for the first few years following which it will be partially imputed at c.80%. Valuation Multiples implied by the prospectus value range of 1.35ps to 1.65ps. We have a sector to benchmark this stock against. The benchmarking needs to consider a relative value based on both a Labour/Green and a National outcome. Also, Genesis has an oil and gas producing asset, Kupe, which has a life of c. 13 years. This asset is highly cash generative and because it has a defined life, its value relative to its near term cash is low, hence it affords this asset a higher dividend yield relative to the NZ Electricity sector average. In order to benchmark Genesis correctly we first derive a value for its Kupe investment, strip this out, and then consider Genesis net of Kupe metric against the electricity utility sector. We calculate an value of NZ$484m for Genesis 31% of Kupe. The following table summarises the valuation multiples for the high and low indicative price range in the prospectus: Figure 13: Dividend Forecast Source: Genesis Energy, CIP estimates At $1.65 the EV/EBITDA equates to a 8.0x FY14 EBITDA estimate for the group. After removing our value for Kupe, the gentailer business is on 9.3x normalised FY14 EBITDA. This appears high relative to the industry. However, on FY15 forecasts, Genesis gentailer business is on a normalised EBITDA multiple of 8.1x, which is a slight discount to peers.

11 Figure 14: Industry EV/EBITDA multiples Source: Genesis Energy, CIP estimates Multitude of outcomes distilled to just two scenarios The New Zealand electricity sector is facing a number of uncertainties, particularly those related to 1) Labour/Green regulatory reform, 2) Tiwai demand shock, 3) the recovery timeframe of its current overcapacity environment, and 4) transmission methodology pricing review. While most of these uncertainties can be modelled via a scenario approach, most of these events are not mutually exclusive and hence it would be cumbersome to model each of the permutations individually. Our approach is to model the National/Labour regulatory scenario at depth and make assumptions for the other industry uncertainties. Our approach is based on our estimate that the outcome of the New Zealand general election (to be held on 20 September 2014) has most material impact on sector earnings, that is, if National win the outcome is likely 20-30% plus better for the gentailers relative to a Labour win. Figure 15: Estimated impacts from various industry risks and conditions National path valuation The National profit path assumes the electricity regime is status quo. The outcome for the gentailers EBITDA forecast is as follows: Figure 16: Normalised NZ EBITDAF forecasts (excludes foreign income) $m Note: MEL s EBITDAF is adjusted for the Genesis Swaption We value Genesis as two businesses, Kupe and gentailer. As we noted above, we value Genesis 31% stake in Kupe at $484m. Our base case National scenario DCF value for Genesis gentailer equates to NZ$1.487bn, which with the Kupe value equates to NZ$1.97bn, or 1.97cps. The DCF value implies that at the bottom end of the indicative range there is 46% upside to National scenario DCF and at the top end 19.5%.

12 Labour path valuation The current Labour/Green proposal for the electricity market, if they win the next general election, is for the adoption of a single buyer model (central control) to remove c. NZ$ m from the wholesale revenue pool. Under a Labour election win in September 2014, we assume that a modification to the existing regime would be implemented in January In applying the Labour/Green regulatory impact to each company s earnings we calculate the following values: Figure 17: Labour Path DCF valuation Note: MECLA target price is 50 cps lower as it has a NZ$0.50 final instalment payment due on 15 May 2015 So, if Labour were to win the next election, and went ahead and implemented a policy that removed $500m from the industry s profit pool, then we would estimate a value of $1.52ps for Genesis. Based on these two outcomes we estimate that, if the prices as at 19 March are used, then Genesis should be trading at c. $1.63ps. This is derived by applying the average of where the currently listed four gentailers trade at relative to their up and down side DCF scenarios. Genesis higher gearing, accelerated depreciation on Kupe and the short duration of the Kupe asset in returning its value to shareholders in dividends explains Genesis better than industry dividend yield potential. The following table compares Genesis dividend profile against its peers using a NZ$1.63 share price. Figure 18: Dividend yields and payout ratios DCF Market Price Upside Contact Energy % Trustpower % MRP % Meridian % GEN % Gen % Source: Genesis Energy

13 Appendix A: Prospective Financial Information Figure 19: Income Statement Source: Genesis Energy Figure 20: Overview of cash flow Source: Genesis Energy Figure 21: Overview of balance sheet Source: Genesis Energy

14 Appendix B: Key risks Industry risks Tiwai Point aluminium smelter: The Tiwai smelter sources its power from Meridian s 850MW Manapouri Power Scheme, and uses c.5,000-5,500gwh p.a. equating to % of national demand. Without Tiwai, it would take 8-9 years to absorb the reduction in demand through the existing level of demand growth expectation. The fall in demand is likely to lead to a sustained reduction in electricity prices. While the reduction in demand from the Tiwai smelter is most certainly a negative for the industry, we have factored into our modelling that Tiwai will reduce its demand from 572MW to 400MW in CY16. With the earliest date at which Tiwai demand reduction could take effect being 1 January 2015, any delay in demand reduction is positive relative to our expectations. Labour/Green policy implementation: The Labour/Green party has proposed to establish a Crown entity to have a central role in the planning and operation of the electricity system. If implemented, we expect a substantial decline in Genesis profitability, as indicated in the Labour path valuation section. Transmission pricing methodology: The Electricity Authority is currently reviewing the transmission pricing methodology. The changes proposed by the Electricity Authority, if implemented, may materially increase Genesis costs. We expect the transmission pricing methodology to be implemented in April 2017 and have a $10m impact on its EBITDAF. Charges on use of water: The Government is in the process of developing reforms for freshwater and resource management systems. Genesis could be adversely affected by these reforms if: 1) they impose restrictions or conditions on its generation activities, or 2) if they impose a pricing regime on water that cannot be passed on to customers. Operational risks Medium term wholesale electricity market exposure risks: Genesis is an active participant in the wholesale market and is therefore exposed to the movement in wholesale electricity prices. Factors that could affect medium term wholesale electricity prices include 1) hydrological condition, 2) market demand, and 3) power station availability. Long term wholesale electricity market exposure risks: The long term wholesale electricity prices are driven by the supply and demand for electricity. Key risk factors that could have result in a subdued wholesale pricing environment includes: 1) continued subdued demand growth, 2) the potential closure of Tiwai Point aluminium smelter, 3) a material gas discovery driving down cost of generation. Fuel Security and supply risks: Genesis generation production is dependent on the availability of fuel, including water for hydro generation and gas and coal for its Huntly Power Station. A reduction in fuel supply or increased costs of fuel may adversely impact Genesis operating results. The following factors may potentially impact fuel security: 1) low hydro inflows, 2) disruption to gas supply, 3) increased competition for fuel resources, and 4) government regulation of resource use and access. Power Station availability risks: Genesis ability to generate electricity is dependent on the continued efficient operation of its power stations. The viability, efficiency or operability of Genesis power stations could be adversely impacted by a range of factors, including 1) plant failure, 2) Tekapo canal and generation unit remediation, and 3) the availability of Huntly being compromised by extreme dry periods where the low water level of the Waikato River restrict cooling water to allow the Rankine Units to fully operate. Locational pricing risks and transmission constraints: New Zealand wholesale electricity market sets prices at different nodes representing different geographic places around New Zealand. The price at the various nodes can vary significantly. As a result the price at which Genesis is able to sell electricity it has generated into the wholesale market and then purchase electricity for its retail sales will vary across its portfolio. The variation in locational pricing may be exacerbated by planned and unplanned transmission constraints. While the HVDC link between the North and South Islands have historically been a key driver for inter island price separation, Transpower has recently upgraded the HVDC link which should reduce the degree and frequency of transmission constraints between islands. The effectiveness of the improved link in reducing interisland price differences is yet to be tested under adverse conditions. Emissions Trading Scheme (ETS): The Government implemented further restrictions on the type of emissions units that may be used for compliance purposes under the ETS. Further amendments of this type could impact on forward trading contracts that Genesis has entered into that are tied to the future wholesale electricity price. There is also a risk that a future government could intervene in the ETS and implement a regulated price for carbon or restricting the use of tradable units.

15 Disclosures and Disclaimers Important Notice and Disclosure: This report has been prepared and issued by Craigs Investment Partners (CIP) independently of Genesis Energy and not at Genesis Energy s authorisation or on its behalf. The information, analysis and views in this report are for class advice purposes only and do not constitute personalised advice. The document does not, and does not attempt to, contain everything material there is to be said about the Company or its business. Although reasonable care has been taken to ensure that the facts stated in this document are fair, accurate and reliable, we have not independently verified the information contained in this document. Accordingly, CIP makes no representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained in this document, and nothing therein shall be deemed to constitute such a representation or warranty or to constitute a recommendation to any person to acquire any securities. Craigs Investment Partners Limited has no authority to give any information or make any representation or warranty on behalf of Genesis Energy. Any decision to purchase or subscribe for securities should be made only on the basis of the official offering documentation. Before making an investment decision, investors must consider whether they have sufficient information having regard to their particular investment needs, objectives and financial circumstances, and may need to seek financial advice. None of the offering documentation or this document constitutes an offer to sell, or a solicitation of an offer to buy, securities in any other jurisdiction. Any New Zealand resident wishing to apply for shares in the offer will need to complete the application form that will be in, or will accompany, the offering documentation. Disclaimer: This report is not intended for distribution to any person outside New Zealand except in accordance with all the legal requirements of the relevant jurisdiction. Craigs Investment Partners (CIP) did not take into account the investment objectives, financial situation or particular needs of any particular person in the preparation of this report. Nothing in this report constitutes a representation that any investment strategy or recommendation is suitable to your individual circumstances or otherwise constitutes a personal recommendation. Accordingly, before making any investment decision CIP and/or its partners and employees may, from time to time, have a financial interest in respect of some or all of the matters discussed. The research analyst or analysts responsible for the content of this research report certify that: (1) the views expressed and attributed to the research analyst or analysts in the research report accurately reflect their personal opinion(s) about the subject, securities and issuers and/or other subject matter as appropriate; and (2) no part of his or her compensation was, is or will be, directly or indirectly related to the specific recommendations or views contained in this research report.