Why shares of ERM Power Ltd have dropped 6% today

Shares of ERM Power Ltd (ASX: EPW) have fallen sharply today, driven lower by the group’s earnings results which were released to the market this morning. The shares are down 6.6% at $1.06 at the time of writing, and have lost more than 32% of their market value so far in 2016.

As the name would suggest, ERM Power is an energy retailer and generator. Although it has recorded strong revenue growth over the years, its earnings results have been somewhat less impressive.

That trend continued today. Revenue and other income grew 19% for the year to $2.76 billion, but underlying net profit after tax dropped 41% to $19.2 million. Operating cash flows (before changes in working capital) were also 8% lower at $80.6 million, while its operating profit (EBITDAF) fell 14%.

ERM Power noted that the key driver of the decrease in operating profit was the expiration of the Oakey Power Station offtake contract, which has since failed to meet expectations as a merchant facility. An improvement is expected in the current financial year.

There have also been issues within ERM Power’s Australian electricity retailing business. In a market update in June, the company said the business was approaching its natural market share ceiling, whereby lower margins could also be a lasting effect due to “significant retail competition”.

Unfortunately, that margin pressure is expected to continue in the 2017 financial year, while management is also forecasting a growth rate “slower than historic levels” for sales volumes.

Pleasingly, however, the US electricity retailing business continues to show strong lead indicators, whereby the annual sales volume is tipped to double to about 5 terawatt hours (TWh).

Although ERM Power’s shares have fallen to reflect the headwinds facing the business, it could still be a somewhat risky play for investors today. Right now, I think there are plenty of safer businesses you could look to invest in instead.

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Motley Fool contributor Ryan Newman has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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