Jersey Electricity — Managing transition well

Jersey Electricity (JEL) is the sole supplier of electricity to the island of Jersey. The electricity business is responsible for generating around 75% of group revenues and operating profits. JEL also operates a range of other businesses including property rental, retail and business services. The Government of Jersey (GoJ) remains the largest shareholder, with 62% of the ordinary share capital and 86.4% of the voting rights. JEL’s core objective is to supply Jersey with secure, affordable and sustainable electricity.

JEL sources its electricity principally from undersea cables from France (Jersey is 12 nautical miles off the coast of France). In H123, these cables account for 96% of energy delivered to customers, with an energy to waste plant owned by the GoJ generating the remaining 4%. A small proportion of overall energy (0.4%) comes from a traditional oil-fired plant that is run during testing regimes and solar generation.

Although JEL carries out a range of other activities, the dominance of energy means the key driver of earnings is the spread between wholesale power prices and consumer tariffs. It must therefore balance two key factors:

Due to the self-regulated returns nature of the energy business, long-run profitability growth is partly due to volume growth in energy and margin expansion in the other businesses. In energy, we forecast that units sold will grow at a CAGR of 2% from FY24 to FY30, from flat demand growth in recent years. This is due to our assumption that decarbonising the economy will see electricity demand grow (in the displacement of hydrocarbon heating and other use such as electric vehicles, EVs) and this will offset efficiency gains.

In our view, JEL is an attractive stock to investors for a variety of reasons. As it earns a self-regulated return on assets over the longer term, it ultimately passes power price changes and also general inflationary cost pressures for its non-power costs through to consumer tariffs. It has a strong balance sheet, is attractively priced, has a progressive dividend and is set to benefit structurally from ongoing power demand growth due to decarbonisation policies. We project net cash/EBITDA of 1.0x by the end of FY23 (ie a positive net cash position equal to EBITDA), helped by a £3.6m rebate from RTE. This could enable higher capital returns, but we see this as a peak, with net cash/EBITDA slowly easing back to 0.8x over the next two years, and we expect JEL to maintain a robust balance sheet through the uncertainty of wholesale tariff purchase arrangements from FY25. JEL could also choose to accelerate capital spending for the energy transition.

In a rising interest rate environment, utility companies with relatively fixed or regulated returns can underperform the broader market. JEL seems to have unjustifiably underperformed many of its peers over the past six months. It is trading on an FY23e P/E of 13.0x and EV/EBITDA of 4.7x (relatively low due to the positive net cash position). Allowing for 5% dividend growth in FY23, JEL offers a prospective dividend yield of 4.5% and should be able to grow this by c 5% per year.

We have updated our earnings estimates to incorporate FY22 and H123 results, as well as revising our forecasts from these changed levels. Volumes of electricity sold in FY22 were slightly lower than we forecast (due to a mild winter, slower cannabis industry sales and a reduction in home working post pandemic), but were somewhat offset by higher prices (which also reflect higher input costs of power purchased). Inflation of non-power costs also led to EBIT and EPS results that were lower than we forecast. We had forecast a 1.3% rise in units sold in FY23, but have revised this to a 0.5% contraction (H1 volumes were 1% lower year-on-year). We remain of the view that the growth of end-use demand for electricity due to decarbonisation will accelerate, but we have pushed this acceleration out slightly. Our revenue forecasts are similar to our previous estimates, but they are driven more by tariff pass-through than unit volume growth. As such, we have revised down both earnings and EPS.

Jersey is an island with 46.2 square miles of landmass. It has a population of around 111,000 and its own financial, legal and judiciary systems. Its constitutional relationship is with the British Crown but it is not part of the United Kingdom. The financial services industry (with sterling as its local currency) forms a large part of its economy. Jersey sets its own utility regulations, climate targets and corporate taxation regulations. This backdrop, plus the majority ownership of JEL by the GoJ, means that JEL’s growth prospects and strategy need to be considered in this specific context. JEL has more than 52,000 business and residential customers.

JEL operates on a self-regulated basis with two self-imposed regulatory targets:

JEL is able to manage its returns through consumer tariff changes. It imports c 95% of its electricity from France through EDF, so a sustained upward movement in French wholesale prices and/or a deterioration in the foreign exchange rate would require JEL to raise tariffs to preserve its rate of return. Naturally, managing the rate of change, the relative price of electricity for consumers and foreign exchange rates (it buys electricity in euros) are all considerations that make returns less straightforward. JEL’s 15-year agreement with EDF runs until the end of FY27.

In terms of regulated returns, the return on energy assets in FY22 was 4.2%, down from 6.0% in FY21 and 6.8% in FY20. On a rolling five-year basis, regulated returns were 6.2% at the end of FY22 and have tended to remain within the 6–7% target range, although they were slightly below this range in 2015 and 2016 (5.8% and 5.5% respectively). Similarly, we expect regulated returns to slip back marginally below 6% over the next few years on a rolling basis, due to rising wholesale power input costs as a result of fixed price hedges rolling off.

In H123, JEL received a £3.6m rebate from RTE regarding payments made by JEL in 2022. We have not included this gain (classified as a non-recurring item) in our regulated return estimates in 2023, as it is a one-off and unexpected refund of past electricity purchasing costs, although it would be allowable within overall return limits according to our estimates (4.7% in FY22 excluding this rebate, 5.7% including this rebate). RTE awarded the rebate to JEL as part of a regulatory decision due to volatility in the energy marketplace during 2022.

As stated above, JEL’s self-imposed regulatory goal is to ensure its tariffs remain within ±10% of the EU-15 average (inclusive of all taxes). JEL aims to smooth tariff rises in the context of being more exposed to electricity prices in 2025. Based on our long-term wholesale electricity price assumptions, we expect additional tariff rises of 3.5% in real terms, but this does assume an easing and stability in long-term prices, hence JEL must consider the amount of risk it presents to its customers.

In June 2023, JEL announced that it will freeze its current tariff prices until the end of 2023. However, from January 2024 a 12% increase in tariff prices will be necessary to maintain prices in line with rising costs as a result of the volatility of international energy prices. The rise is in line with the All Items Jersey Retail Prices Index of 12.7% and overall will add c £3 per week to the average domestic electricity bill of around £1,200 per year. On a fiscal year basis, we believe this corresponds to tariff rises of 7.2% in FY23 and 10.3% in FY24, and we have allowed for these increases in nominal terms in our modelling.

Management stated that although JEL has a strong contract with a favourable hedge position that has generally sheltered Jersey residents greatly from the turmoil in the European energy market over the last 18 months, it is not fully hedged nor completely immune to this volatility. Despite an easing in European wholesale energy markets in recent months, these prices remain high in comparison to JEL’s current import costs. Additionally, the attractive hedges in place until 2025 that provide stability are on a rising cost trajectory, which means that the underlying costs that JEL needs to pass on to consumers are also rising. The consequences of the above factors, together with general inflationary pressures, were the reasons JEL gave for the tariff increase at the start of 2024.

In comparison with other jurisdictions, JEL estimates that by the time the tariff increase is supplemented, Jersey’s standard tariff has recently been roughly half of the equivalent UK tariff. Other island territories adjacent to the UK are also raising consumer tariffs, for example Manx Utilities, which is based on the Isle of Man, implemented a 34% rise in electricity prices between 1 April and 1 July 2023, while Guernsey Electricity has announced a 13% rise from 1 July 2023.

Under self-regulatory aims, JEL must also ensure that its tariffs remain within ±10% of the EU-15 average (inclusive of all taxes). Exhibit 3 shows EU-15 retail electricity prices for H222, which are the latest available data from Eurostat. We use JEL’s currently advertised standard tariff domestic price of 17.99p/kWh (or 21.05c/kWh), which is 18% below the EU median price for H222.

A rise in volumes through JEL’s existing infrastructure due to decarbonisation could increase returns and help mitigate tariff rises. JEL’s volumes of power delivered to consumers have been relatively static in recent years, but we believe decarbonisation efforts could lead to structural growth of c 2%.

The publication of the GoJ’s Carbon Neutral Roadmap in April 2022 set out milestone and policy changes to enable Jersey to be carbon neutral by 2030. This has put greater emphasis on growth and provided additional external pressure on JEL, generating significant opportunities for economic growth. The high-emitting sectors of heating and road transport, which together represent more than 80% of overall carbon emissions, are the areas JEL is targeting the most. JEL plans to convert c 20,000 fossil fuel boilers to electric heating and implement large-scale overnight EV charging. JEL 30has been reassured by the GoJ that the first £23m of government funding from the Climate Emergency Fund is secure for the first four years of the roadmap.

Two of the key policies surrounding heating in the Carbon Neutral Roadmap are:

JEL’s Energy Solutions team, which was formed seven years ago and was designed specifically to develop customer propositions to deliver growth through fuel switching, has continued to grow its organisational capability. Although unit sales fell slightly to 613m kilowatt hours in FY22 from 639m in FY21, in FY22 JEL exceeded its internal target of domestic fuel switches for the third year in a row, converting 325 premises to electric boilers.

Key policies in the Carbon Neutral Roadmap relating to transport are as follows:

The decarbonisation and transition of road transport to electric power is vital for JEL’s net-zero goal, as Jersey’s transport emits c 44% of the island’s emissions. Some of the key areas on which JEL is focusing for growth in this space include public and home EV charging points. With EVs becoming ever more popular and as the uptake in electric transport grows, JEL’s strategy is to ensure that its networks are ready to meet and can cope with the increase in electricity demand while having a wide range of infrastructure already in place.

At the end of FY22, JEL had expanded the number of its public charging networks to 109 charging points in service, up from 95 at the end of FY21, which is twice the UK average per capita. This includes the Channel Islands’ first ultra-rapid charger at JEL’s Powerhouse headquarters.

In May 2022, JEL launched its innovative, all-inclusive home EV charging subscription service, Easycharge. The service provides customers with charger installation, maintenance and overnight off-peak electricity for a fixed monthly subscription. The Easycharge service not only supports customers by offering affordable and more convenient charging, but also enables JEL to better manage load and avoid higher network costs through moving load from peak times to off-peak overnight when there is spare capacity and energy costs are cheaper. The three subscription options are £30 a month for single EV households, £45 a month for multi-EV homes and £85 a month for commercial or high-mileage users. The total number of EVs registered in Jersey at the end of 2022 was 1,688, which was c 25% higher (427 vehicles) than at the end of 2021.

As can be seen in Exhibit 4, the expected percentage of new EV sales of total new vehicle sales must and will continue to increase significantly in the run-up to 2030. This is in line with GoJ policies surrounding transport to successfully achieve net-zero by 2050. This therefore shows how the EV market promises to be a great growth area for JEL, especially the domestic charging market.

The EV percentage of total registered vehicles within Jersey (parc), however, needs to increase faster than the rate that it is currently forecast to grow by if carbon neutrality is to be reached by 2030.

Solar photovoltaics (PV) is another area that offers ‘potential for growth. Through a combination of the global energy crisis and the GoJ’s Carbon Neutral Roadmap to net-zero, the island of Jersey is more than ever focusing on energy sovereignty. JEL has continued the progress of its utility- and commercial-scale solar PV with a 4MWp site in the Parish of St Clement, which has now been given the go-ahead for construction, and reaching a landowner agreement for a further 3MWp side on the north coast at Sorel. In March 2022 JEL installed 1,500 solar panels on the roof of the Albert Bartlett potato processing plant, providing up to 612kWp, with the array being the largest in the Channel Islands. The sites mentioned above, and two other ground-based sites, could bring on-island generation to 15MWp. With 90% of the company’s stakeholders supporting the use of solar panels for expansion and 23% of homeowners stating that they are likely to consider solar panels within the next 12 months, there are huge growth opportunities, in both domestic and large-scale solar, with the aim of reaching net-zero.

Looking slightly further into the future, JEL has held constructive conversations with the new minister for the environment and is continuing to research and assess the use of offshore wind. The GoJ and the Bridging Island Plan both agreed that an offshore wind farm could bring large strategic value to Jersey. An offshore wind project could not only bring greater energy independence to Jersey, but, if the project was at scale, provide more energy than the island needs. This therefore provides a commercial opportunity allowing Jersey to become a net exporter of energy.

JEL buys electricity from EDF, and we understand that the pricing structure is split into two parts, approximately one-third fixed and two-thirds market-based pricing. In addition, there is a transport cost payable to RTE. We believe JEL has a capped price element in FY23 and FY24 with EDF. While the caps are not explicitly published, we assume that they are similar to wholesale prices before the energy crisis in H121, which were €50–55/MWh on a two- to three-year forward basis. This has insulated JEL customers from a full pass-through of wholesale energy prices, which have been extremely volatile over the past 18 months (see Exhibit 6 below), principally due to the conflict in Ukraine, and the subsequent impacts on natural gas markets and prices. JEL also has around one-third of its expected FY25–27 requirements at largely fixed prices.

Wholesale prices have eased from peak levels but are very volatile and still relatively high (spot prices have fluctuated between €50/MWh and €120/MWh in recent months and three-year forward pricing is in the region of €100–110/MWh after falling from peaks of €390/MWh in September 2022). We assume a long-term price of €80/MWh (real) from FY25 (up from €70/MWh in our last review, partly due to inflation and partly due to strength in forward energy prices).

The longer-term equilibrium price is naturally highly uncertain, but we have modelled retail prices and imported energy costs to reflect the self-regulated return on energy assets of 6–7%. We estimate that tariff increases of 5% in FY24 and 3.5% in FY25 (in real terms from 2023 average tariff rates) are required by FY25, to maintain return on capital for FY25 in the 6–7% range.

JEL’s focus is on delivering secure, low-carbon electricity supplies while maintaining relative stability in its customer tariffs, despite the recent volatility that has been seen in both the European wholesale electricity and foreign exchange markets.

JEL has a power purchase agreement with EDF in France and as of 30 September 2022, the company’s import prices, but not volumes, were substantially fixed for 2023. The group originally entered a 10-year framework with EDF in January 2013; the framework has a commitment to procure around 35% of expected volume requirements at known prices with the remainder of the requirements being decided by a market pricing mechanism, with no volume commitment. The agreement was extended in 2017 a further five years past its original end date in 2022 to 2027. This contract is a combination of a fixed-price component with the ability to fix the price of future purchases over a rolling three-year period based on a market-related mechanism linked to the EEX European Futures Exchange.

The company’s electricity purchases through this agreement are materially but not fully price capped for calendar years 2023 and 2024. JEL also has roughly one-third of its expected 2025–27 requirements hedged at largely fixed pricing. As these contracts are denominated in euros, the company enters forward foreign currency contracts, on a three-year rolling basis, to reduce the volatility of costs and to aid tariff planning.

The average euro/sterling rate underpinning JEL’s electricity purchasing price during FY22, as a result of its hedging programme, was €1.13/£, and the applicable spot rate during the same period was €1.18/£ against €1.15/£ during the FY21.

JEL aims to minimise outages (which are relatively low compared to the UK), and the key risk is the capacity of the undersea power cables. In May 2013, JEL and Gurnsey Electricity Limited signed an agreement to share the cost and capacity of the £70m Normandie 3 (N3) project. It also provided for the cost and capacity sharing of the £30m Normandie 1 (N1) 100MW undersea cable which was installed in 2016, as a replacement of the original EDF1 (55MW) interconnector between Jersey and France that failed in June 2012. When combined with the existing N2 and N3 cables which as of December 2014 operate in parallel, N1 gave the Channel Islands access to 245MW of import capacity.

Following the completion of the 75MVA 90/33kV transformer at La Collette, work on a new 90/11kV transformer at Queen’s Road became part of the long-term development plan for JEL’s 90kV network. This project will allow the eventual decarbonisation of the ageing 33kV cable interconnectors between Queen’s Road and La Collette, providing further options to enhance supply security and facilitate the load growth that net-zero will bring, and allowing more generation plants to be installed at La Collette.

Further investment will be necessary for JEL to be able to meet the increase in peak demand and annual consumption that net-zero will bring. Additional capex for the decarbonisation of Jersey (mentioned above) will be needed to help orchestrate and smooth the transition to net-zero. For example, capex will be needed for: the build out of the island’s EV infrastructure and charging stations and the increase in solar PV. Our forecast (see Exhibit 11) is for capex to rise to 1.8x depreciation in FY24, towards the top of historical ranges, but not at record levels. In its FY22 annual report, JEL outlines that its five-year capital spending approved by directors was £94m, or £18.8m/year on average.

JEL’s retail business (c 14% of overall revenue for H123), also known as The Powerhouse, is Jersey’s largest retailer of domestic electrical appliances. Some of the products the store offers include home computing, smart tech, mobile phones and electric transport, all both in-store and online. Services range from delivery to professional installation and servicing of its products. Year-on-year revenue in H123 for the Powerhouse retail business increased by 5% to £10m (H122: £9.5m), although profits maintained a similar level at £0.7m. The segment’s EBIT margin was 6.7% in the period, similar to the 6.9% seen in H122.

The company’s property portfolio (c 2% of overall revenue for H123) consists of business units and private dwellings. The portfolio is comprised of the Powerhouse Retail Park as well as around 30 residential properties, which were originally built to house employees. Some of the tenants now include B&Q, telecommunication company Sure (Jersey) and a large modern medical centre. The portfolio’s profit of £0.8m for H123 was £0.1m higher than H122, due to a combination of higher rental and slightly lower maintenance costs. Revenues for H123 were up 4.5% year-on-year, with the EBIT margin at 51% for the period, up from 48% in H122.

Jersey Electricity Building Services (JEBS) (c 2% of overall revenue for H123) offers a range of building and maintenance services to both domestic and commercial customers including electric heating and heat pump installations, street lighting and EV charging infrastructure. H123 saw JEBS’s revenue fall 1% year-on-year, with its profit breaking even.

JEL’s remaining business operations consist of Jersey Energy (a consultancy offering mechanical electrical and public health services for construction projects, business and buildings) (c 3% of overall revenue for H123), Energy Solutions (which advises on domestic and commercial low-carbon electrical technologies, fuel switching from gas and oil and EV charging), Jendev (an in-house software configuration business focusing on developing and implementing solutions for the utility industry) and Jersey Deep Freeze (which installs and maintains refrigeration and other catering equipment). Across these four businesses, revenues for H123 fell 1.4% year-on-year, with profits dropping to £0.2m in H123 from £0.3m in H122. The EBIT margin for H123 was 15.4%, up from 14.1% in H122.

For the period FY22–25 including our forecasts for FY23–25, we see a 5.3% year-on-year average growth in revenue and a 2.7% average year-on-year growth for recurring EBIT for JEL’s energy business. The steady growth in revenue for the energy business is due to the steady tariff increases JEL is implementing between FY22 and FY25 (5% in June 2022, 5% in January 2023, 12% in January 2023), while the majority of its energy requirements are hedged until 2025.

We value JEL using the average of a 10-year DCF (675p) and our SOTP (769p) for an overall valuation of 722p. This is down from 800p in our last report, principally due to a reduction in earnings. We have raised our long-term electricity price from €70/MWH to €80/MWH to reflect our view that volatility is likely to continue and raise long-term prices.

For our DCF valuation, we assume a WACC of 6.0%, based on a beta of 0.9x, cost of equity of 6.3% and cost of debt of 4.5% (with total debt at c 15% of capital), unchanged from previously. Our valuation assumes a terminal growth rate (TGR) of 2% (unchanged) and reflects of forecasts of underlying demand growth due to decarbonising the Jersey economy (electricity displacing other fuels). We outline the sensitivity of our DCF to our assumptions in WACC and TGR in Exhibit 9.

Our SOTP valuation values JEL’s regulatory assets at £177m based on their book value and assumes JEL earns a return on these assets equal to its cost of capital(unchanged from previously). We also value the property business (rental properties owned by JEL) using a balance sheet carrying value. For the other minor assets, we apply a 10x earnings multiple.

As a cross-check, we compare the P/E multiples of our valuation against the appropriate peers (focused on the grid and energy transmission). These are National Grid (UK), Red Electrica Corporacion (Spain) and Terna Rete Electtrica Nazionale (Italy). The forward (2024) P/E multiple for this peer group is currently 16x. Applying this to our FY24 EPS of 32.9p results in a valuation of 526p, which is lower than our DCF (675p) but still significantly above the current stock price. Due to its relatively smaller scale and specific decarbonisation goals, JEL arguably has higher growth prospects than its peers.

Profitability and returns: our forecasts for FY23 and FY24 assume that JEL’s core energy business aims to deliver profitability within the range of the targeted return of 6–7%. For FY22 the reported return on energy assets was 4.2%, with a five-year rolling return of 6.2%. Profit in the energy business totalled £7.5m in FY22, which was lower than the £10.7m achieved in FY21. This decrease was largely due to lower unit sales volume in 2022. We forecast a return of 4.7% in FY23, which includes the 5% tariff rise imposed in January 2023. This suggests an increase in profits for FY23 (forecast recurring operating profit of £10m vs £7.5m in FY22). We forecast that there will be a further increase to 5.9% in the return on energy assets in FY24 due to the announced 12% tariff increase in January.

Through FY25–27, where JEL has roughly one-third of its requirements hedged at largely fixed prices, we forecast returns of 6.0%, 6.2% and 6.5% respectively, which assumes a further c 5% tariff increase in FY25 (in real terms from 2023 average tariff rates) and 3.5% in real terms in FY25, to maintain return on capital for FY26/27 in the 6–7% range.

Capex: JEL’s capital expenditure for FY22 was c £11.3m. The increase in capex for FY23 and FY24 includes an estimated £10m per year investment in a new gas turbine plus an estimated £4m investment in a new transformer at Queen’s Road, as well as any additional expenditure for further growth and investment following the publication of GoJ Carbon Neutral Roadmap.

Pensions: JEL has a defined benefit pension scheme on its balance sheet, which was closed to new members in 2013. The surplus at 31 March 2023 was £30.1m, up from £26.4m at 30 September 2022 and £22m at 31 March 2022. Assets in the scheme rose by £8m to £121m against a liability increase of £5m to £91m (driven by a rise in discount rate assumptions from 5.2% from 4.7% a year earlier). Unlike many UK schemes, the JEL pension is not funded to pay mandatory annual rises post-retirement. In H1 FY23 the pension scheme trustees asked JEL to consider granting a 3% rise to pensions given the level of scheme surplus and the increase in the cost of living. This was agreed in March and, although funded by the scheme rather than the company, it generated a £1.4m charge against the income statement in that half. Given the unique nature of the pension arrangements (a growing surplus but with cost-of-living adjustments made on an ex-gratia basis) and a growing interest rate environment, we have removed the pension surplus from our valuation of enterprise value of JEL. While the pension assets and liabilities both remain on JEL’s balance sheet, in a high interest rate (and cost of living) environment, liabilities for further increases on an ex-gratia payment basis cannot be excluded. We have previously included an allowance for some pension surplus in our valuation, but believe a cautious approach is to exclude this surplus from our valuation at present.

Tax: for tax payable (P&L), we assume an effective tax rate of 20% for FY23 and FY24 (FY22: 20%).

Dividends: our forecasts assume a c 5% increase in the DPS for FY23 and FY24 (19.5p and 20.6p), with a cash impact from payments of £5.8m (FY22 final plus FY23 interim dividend) and £6.1m (FY23 final and FY24 interim dividend). The DPS is forecast to be substantially covered by earnings: 1.4x in FY23 and 1.9x in FY24.

Cash flow and balance sheet: in the absence of any repayment of outstanding long-term debt of £30m (which expires in 2034 and 2039) or a special dividend, we forecast that cash and cash equivalents will increase to £56.2m in FY23 (FY22: £47.4m up £4.3m from FY21). We also forecast that cash and cash equivalents will slightly increase in FY24 to £58.7m.