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Regulation can be good for companies – and investors

This week, Spark Infrastructure Group (ASX: SKI) reported an underlying profit of $141m for the first half of 2012 which is a 19% increase on the previous period. The company said that the underlying assets “… have again demonstrated their resilience with a solid performance in a challenging environment”.

Spark invests in regulated utility companies and currently owns 49% of three electricity distributors, CitiPower and Powercor in Victoria, collectively known as CHEDA, and ETSA Utilities in South Australia. The distribution companies own the physical electricity network of poles, lines, substationsand retailers, which sell electricity to consumers and businesses, and pay tariffs to use the network.

Because the networks are monopolies in the areas they serve, a government agency, the Australian Energy Regulator, determines the tariffs. It allows regular increases in tariffs so, even though electricity sales volumes were flat, revenues increased.

Rick Francis, Spark’s Managing Director said “The Asset Companies will benefit from growing cashflows over the remainder of their current regulatory periods to 2015 as they continue to recover revenues related to regulatory approved growth capital expenditure for network augmentation, security of supply, the smart meter roll-out and other important projects designed to improve services and reliability to customers”.

Spark stated that the regulator has approved capital expenditure over the current five year period which should result in compound growth of around 14% per annum in Spark’s equity investment in the underlying assets.

The ASX code SKI, is a security which comprises a loan note plus a unit issued by the Spark Trust. Thethe current cash distribution of $0.0525 includes an interest payment of $0.0352 and a capital distribution of $0.0173. What this means is that the distributions do not have any franking credits so you pay tax normally on the interest component and you effectively pay capital gains tax on the capital distribution only when you dispose of the shares. Nothing like simplicity, is there!

The company reaffirmed that it expects the full year distribution to be $0.105 and expects distributions to grow by 3%-5% per annum.

If you are interested in investing in regulated utilities, you might consider a similar company such as SP Ausnet (ASX: SPN) with interests in electricity and gas in Victoria. Perhaps you might look at airports through Auckland Airport (ASX: AIA), Infratil (ASX: IFZ) or Sydney Airport (ASX: SYD). Or how about the DUET Group (ASX: DUE) with interests in pipelines, energy and gas?

Foolish takeaway

Spark has stable, predictable revenue streams which provide an understandable investment case at the right price. It has recently internalised and simplified its management structure but it seems that  the company has ambitions to grow as evidenced by its unsuccessful bid for the Sydney desalination plant.

While it states that it would only invest in other regulated utility assets such as electricity, gas, water and sewerage, these would probably need capital raisings which makes for a less certain future, as does the regular pricing review by the AER.

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More reading:

Motley Fool contributor Tony Reardon owns Spark Infrastructure securities. The Motley Fool‘s purpose is to help the world invest, better. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription, whilst it’s still available. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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