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Edited Transcript of SKI.AX earnings conference call or presentation 26-Aug-19 11:30pm GMT

Half Year 2019 Spark Infrastructure Group Earnings Call

Sydney, New South Wales Aug 31, 2019 (Thomson StreetEvents) -- Edited Transcript of Spark Infrastructure Group earnings conference call or presentation Monday, August 26, 2019 at 11:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Nicholas Schiffer

Spark Infrastructure Group - CFO

* Richard F. Francis

Spark Infrastructure Group - MD, CEO & Executive Director

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Conference Call Participants

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* Ian Myles

Macquarie Research - Analyst

* James Nevin

RBC Capital Markets, LLC, Research Division - Senior Associate

* Nathan Lead

Morgans Financial Limited, Research Division - Senior Analyst

* Robert Koh

Morgan Stanley, Research Division - VP

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the Spark Infrastructure Half Year 2019 Results Briefing Conference Call. As a reminder, this conference is being recorded on Tuesday, the 27th of August of 2019. Your speakers today will be Mr. Rick Francis, Managing Director and Chief Executive Officer; and Mr. Nick Schiffer, Chief Financial Officer.

And it is now my pleasure to turn the conference over to Mr. Francis. Please go ahead.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [2]

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Thank you, Nicole. Good morning, and thank you for joining us today for our 2019 half year results call. As usual, and for the last time, I'm joined by our CFO, Nick Schiffer, who will touch on the key points in the financial results. And for your information, we have a few other people here. We have Alex Finley, our General Counsel; and also Sara Musgrave, who is heading up our Investor Relations. We've also included additional financial detail in the appendices as per usual.

So moving on to Slide 2, Spark Infrastructure at a glance. And apologies if you've heard this before but always useful to revisit. So as you know, Spark invests in leading essential services infrastructure businesses currently within energy in Australia. Our businesses are helping meet Australia's future energy needs and transition while delivering healthy and consistent returns for securityholders, whether that be through asset-based growth or through regular cash flow distributions.

So a quick reminder of our 4 investments: 49% of South Australia Power Networks, or SAPN, the sole operator in South Australia's electricity distribution network, supplying around 880,000 residential and commercial customers; 49% of CitiPower and Powercor, together known as Victoria Power Networks, or VPN, distributing electricity to over 1 million customers in Melbourne and Western Victoria; 15% of TransGrid, the largest high-voltage electricity transmission network in the NEM and operating in New South Wales and the ACT; and our new business, 100% of the Bomen Solar Farm project which is currently under construction north of Wagga Wagga in New South Wales.

On a total regulated and contracted asset base basis, our proportional [say] share of RCAB was $6.2 billion, an increase of 3.3% over the last 12 months. 83% of that proportional asset base is in the SAPN and VPN electricity distribution businesses, with the remaining 17% of that proportional asset base in the TransGrid transmission business. And of course, the Bomen Solar Farm is under construction, so immaterial at this point, but growing.

Slide 3, the financial highlights for the half year. And a couple of things to explain first. Our results for this half include some impacts from the acquisition of Bomen Solar Farm in April and from the first payment of tax we have made relating to the prior year. This makes it a little more complicated to compare between periods. So we've adjusted for this, and we'll call it out where we do so. Also in the investment business results, there are also some noncash provision revaluations and reversals that would otherwise make half-on-half comparisons more complicated. Again, we've adjusted for these to better improve comparison. And again, we call it out where we've done so to be completely transparent.

So in the half year, on a like-for-like basis, excluding those one-off acquisition costs for Bomen Solar Farm of $2.6 million and tax paid in the half of $13.8 million, which relates to the full year 2018, adjusted stand-alone operating cash flow was up 10.8% to $144.4 million, driven primarily by 10.6% increase in distributions from our investment businesses. In particular, we're pleased to see the higher distributions continuing to flow from TransGrid following the establishment of the new funding vehicle on 1 July last year for its renewable connections assets.

Notwithstanding the current low inflationary environment and with prudent capital spending, our proportional RAB grew 3% to $6.1 billion from June last year, while TransGrid's contracted asset base has grown 27% to $509 million since 31 December. Aggregated proportional gearing was 74.3% at 30 June, up from 73.9% previously with no drawn debt at the Spark level. The Board has declared an interim distribution of $0.075 for half year '19 and reaffirmed distribution guidance for 2019 of at least $0.15 per security, always subject to business conditions. And as previously guided, we've also announced today that we've reactivated the DRP for the half year to support the equity funding of Bomen Solar Farm. The DRP is not underwritten, and securities will be offered at a 2% discount to the 5-day VWAP which commences from after when the securities go ex on 3 September.

Looking at the stand-alone cash flow. Spark's stand-alone operating cash flow before the adjusting items decreased 1.8% to $128 million. However, as previously mentioned, on a like-for-like basis, adding back the one-off acquisition cost from tax paid for the previous year, adjusted stand-alone operating cash flow increased $14.1 million or 10.8% to $144.4 million. Either way, the half year distribution of $0.075 per security was fully covered.

Total distributions received from VPN was $75.9 million, up 1.6%. And distributions received from SAPN were $55.2 million, up 0.9%, reflecting another good period of operations for both businesses. Total distributions received from TransGrid were $21.5 million, up 150%. As previously reported, distributions for TransGrid were constrained in prior periods due to TransGrid retaining surplus cash in part to fund investment in unregulated infrastructure connection assets and from low inflation. And as you saw at full year 2018, TransGrid Services was established at the end of June 2018 as the vehicles own and operate TransGrid's unregulated business, which has enabled distributions to recommence on a normal basis from the second half of 2018.

Spark's recurring corporate expenses were basically flat at $8.3 million for the half. Bomen-related transaction bid cost of $2.6 million paid, which mainly comprised due diligence and adviser fees, are not able to be capitalized under accounting standards and, hence, are shown as an operating outflow and an expense in the P&L. Bomen operating cost paid of $0.8 million primarily relate to annual premiums on insurances going forward.

During the half year, Spark paid $13.8 million of tax in relation to full year 2018. The total tax payable in relation to 2018 was $16.9 million, with the remaining balance of $3.1 million being paid in July. Based on stand-alone operating cash flow of $128 million for the half, we had a payout ratio of 98.5%, and the cumulative payout ratio for the first 3.5 years of the current SAPN and VPN regulatory period was around 90%. While on an adjusted basis, the payout ratio was 87.4% for the half.

So on that basis, I'll now turn over to Nick who will take us through the financial results for the investment businesses. Thanks, Nick.

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Nicholas Schiffer, Spark Infrastructure Group - CFO [3]

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Thanks, Rick. Turning to Slide 5. On an adjusted proportional basis, our investment businesses delivered a consistent result with total revenue of $577.1 million, up 2.4%. Adjusted operating costs were $158.2 million, up 4.1%. This increase relates in part to increased vegetation management costs at Victoria Power Networks and South Australia Power Networks. On this page, we have made a number of noncash adjustments to operating costs as detailed in Note 1. These relate to noncash revaluation adjustments to employee entitlements, credit valuation hedge accounting adjustments and the prior period relief of a storm provision no longer required. Adjusted proportional EBITDA of $426.4 million was up 1.9%, with SA Power Networks and TransGrid driving the increase.

Now turning to Victoria Power Networks' result on Page 7. In half year '19, EBITDA reduced by 3.4% to $413.6 million and, on an adjusted EBITDA basis, reduced by 0.8%. On relatively flat revenues, up 1.2% to $573.7 million, operating cost in half year '19 increased by $23.1 million as a result of higher vegetation management and clearance costs plus various noncash items. For the half year, Victoria Power Networks spent an additional $19 million on vegetation management costs. These have increased for this half as the cutting program has been accelerated and is well ahead of the equivalent 2018 schedule. Importantly, we do not expect the total cutting program budget for 2019 to be materially different to that spent in 2018.

I draw your attention again to the impact on operating costs of noncash items identified in Note 4 on this page. To clarify, we have not adjusted the operating cost as shown. Such adjustments are only made to the adjusted proportional financial results shown on Page 5. Adjusting for the items in Note 4, Victoria Power Networks operating costs would increase by 8.3%. Capital expenditure grew by 4.7% to $221 million largely due to the continuation of the Rapid Earth Fault Current Limiters, REFCL, program. As a result, the regulated asset base grew 3.1% to $6.188 billion from 30 June '18. Period-on-period comparability of Victoria Power Networks finance costs is impacted by noncash credit valuation hedge adjustments. See note 5. After adjusting for these amounts, finance costs increased by 4.6% primarily due to an increase in the senior debt balance. Victoria Power Networks' distributions to Spark increased by 1.6% to $75.9 million.

Turning now to SA Power Networks, Page 9. In half year '19, EBITDA increased by 0.8% to $337.8 million and, on an adjusted EBITDA basis, increased by 3.9%. Distribution revenue growth was 3.6% to $412.6 million inclusive of $11.4 million as STPIS revenues. SA Power Networks' semi-regulated revenues were up by 12.8% to $46.7 million. This increase was the result of a higher public lighting works and increased asset relocation activity partially offset by a decrease in council-funded LED upgrades.

Operating costs were $136.3 million. Again, I draw your attention to the impact on operating cost of noncash items identified in Note 2 on this page. We have not adjusted for the operating costs as shown. Adjusting for these items in Note 2, SA Power Networks' operating cost would increase by 5.9%. Continued investment in the augmentation and maintenance of the South Australia network resulted in capital expenditure -- net capital expenditure of $222.9 million, an increase of 7.3% on the previous half. As a result, RAB grew 3.8% to $4.315 billion from 30 June '18. As with VPN, finance cost increases included noncash hedge adjustments due to bond rate movements, see Note 3. Finally, SA Power Networks distributions to Spark increased by 0.9% to $55.2 million.

Please turn to Page 11, TransGrid. In the half year 2019, EBITDA increased by 7.5% to $352 million, being a combination of increased transmission revenues and reduced operating costs. Unregulated revenue reduced by 8.9% to $74.4 million, which also saw a corresponding decrease in associated project-related operating costs. In unregulated revenues, line modification revenues reduced as a number of projects were completed, while revenues from completed contestable transmission connections grew. Regulated capital expenditure increased by 22.6% to $124.3 million mainly due to the commencement of the Powering Sydney's Future project and a major switching station project. Unregulated capital expenditure increased by 139% in the first half to $106.1 million driven by a number of solar farm connections. The total contracted asset base now stands at just over $500 million. The combined regulated and contracted asset base grew 2.6% to $6.948 billion from 30 June '18.

Net financing costs have declined. This is due to the prior period including $27 million of accelerated amortization of capitalized debt transaction costs. See Note 2. The strong operational performance combined with funding efficiency introduced by the new unregulated subsidiary, TransGrid Services, have resulted in an increase in distribution to Spark Infrastructure to $21 million.

Moving to Page 14, Bomen Solar Farm. Work is progressing very well on the construction of the Bomen Solar Farm, following our acquisition of the development rights in April 2019. All key components have been ordered, with some significant deliveries already on site. Construction is being undertaken by our associate company, Beon, and is running on time and on budget. Acquisition and construction costs to date have been met from cash with the first drawdown of debt projected to take place next month. Equity funding will be introduced over time as previously outlined. And as a result, we've announced today that the DRP has been reactivated for the half year distribution.

Last Friday, we held a golden rose ceremony, marking the commencement of the installation of the first of 310,000 bifacial solar panels. When fully operational, Bomen will produce enough clean energy to power 36,000 homes per year. We expect commercial operations to commence in Q2 2020.

Now turning to Page 15. Our investment businesses have strong and stable balance sheets with 5- to 5.6-year weighted average debt maturities and largely hedged debt books. As always, we've noted here the balance sheet gearing metric of net debt to RAB for each business. We have also noted here the FFO to debt metrics, which is healthy at 15% for VPN, 16.7% for SAPN and 8.3% for TransGrid. The headroom in each of VPN and SAPN is important. We are in an environment where cash flows are under pressure in the next regulatory period. Cash flow credit metrics are likely to be more constrained than balance sheet credit metrics. This is particularly in light of the regulator's decisions announced late last year. We will be providing further commentary on this later in the presentation.

And with that, I'll hand back to Rick to run through the strategy and regulatory developments.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [4]

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Thanks, Nick.

So turning now to an update on regulation and growth, so we're on Slide 17, the price review time lines. So on this slide, we've laid out the price review time lines for the 3 businesses -- 3 regulated businesses. South Australia Power Networks submitted its proposal for their 5-year regulatory period commencing 1 July 2020 on 31 January this year. The AER's draft decision is expected in early October with a revised proposal due in December, and then the AER's final decision will flow through and is expected in April of 2020 next year.

VPN released a public consultation document for their regulatory period in February this year. Their revenue proposal was due to be submitted to the regulator on 31 July; however, will now be submitted on 31 January next year. That's as a result of the Victorian government advising CitiPower, Powercor and all of the Victorian network companies, for that matter, that it is seeking to align the electricity network and retail tariff fees for electricity consumers in Victoria by amending the regulatory period to a 30 June year-end. As such, there will be a 6-month transition period between 1 January and 1 July 2021. The business is in discussion with the Victorian government and the regulators to how this will be achieved in practice.

The next price reviews for both SAPN and VPN will be based on the new regulated rate of return guideline, the RORG, which was set in March this year; and, of course, the amended regulated tax approach. As I said previously and we'll continue to say, there is a pressing need to revisit the new RORG, which has already become outdated and unsustainable in a very short space of time due to the current uncertainty and volatility in the markets and the historical low levels of inflation and interest rates that continue.

Note that TransGrid started its new 5-year regulatory period on 1 July 2018 and therefore has a further 4 years of certainty in front of it. TransGrid will not be subject to the current 2018 rate of return guideline. The RORG is reviewed every 4 years, so a further RORG will be in place before TransGrid's next regulatory period commencing in July 2023.

On Slide 18. You would have seen this slide basically at our AGM. The Australian energy market is in a state of significant transition, we all know that. And we are both leading that transformation through our Bomen acquisition as well as supporting the transition through our network companies. Our businesses are significantly involved in this new energy future which is seeing an increased role for networks, both transmission and distribution. With nearly 2 million rooftop solar PV systems connecting into the distribution grid and a huge pipeline of large-scale renewable generation looking to connect to the high-voltage transmission network, we are well placed to participate and benefit from the accelerating transition.

As AEMO's CEO, Audrey Zibelman wrote in the AFR last week, "we cannot entertain any delay in the construction of transmission that has been identified as necessary to replace retiring power stations and that also increases stability and reduces prices. Investment in the grid is essential. As such, our businesses must be able to operate under an appropriate rate of return which is commercial and encourages and rewards efficient investment."

Slide 19. The growth opportunities in our businesses are healthy. TransGrid's unregulated connections business continues to grow strongly with over 2 gigawatts of solar and wind connections under construction, which will become revenue-producing in future periods. The evolution in the smaller end of the market involving our distribution networks is less advanced but changing nonetheless and is an opportunity for them.

SAPN has recently been successful in gaining $1 million of ARENA funding for a joint project with Tesla and CSIRO to undertake an advanced Virtual Power Plant, VPP, grid integration project. The VPP will start with 1,000 homes and is planned to expand to the largest VPP in the world with 50,000 homes with strong support from the South Australian government. That would equate to around 250 megawatts of solar generation and 250 megawatts of storage through batteries. SAPN's role will provide significant value to the project and will allow the capacity to export up to twice as much electricity at the grid during high-price periods. SAPN's unregulated business, Enerven, has also won a major contract with SA Water to roll out roof and ground-mounted solar panels and battery storage at many of their sites across South Australia. The total revenues from this contract are expected to be around $300 million over the next 2 years.

In Victoria, Beon, owned by Victoria Power Networks, is turning into the preeminent solar farm PPC construction company, having recently completed construction of 112-megawatt Karadoc Solar Farm and 106-megawatt Yatpool Solar Farm, both in Mildura. And of course, they are now underway in construction of our solar farm at Bomen.

Slide 20, AEMO's Integrated System Plan outlines the significant role that transmission and, in particular, TransGrid will play in delivering greater regional interconnectivity and renewable energy zones to better balance the energy system. The inaugural ISP was released in July last year and has gained the support of Energy Security Board, state and federal governments and the AEMC, amongst others, with priority projects that identifies our additional to TransGrid's 2018 -'23 CapEx allowance of $1.25 billion and a number of the contingent projects that were included in their regulatory determination. All of these opportunities could lead to TransGrid making significant capital investments over the next decade.

The challenge that the industry is trying to address currently is that the regulatory framework and RIT-T process is not fit-for-purpose to approve these types of projects within the time frames required and do not provide a suitable return commensurate with the risks involved for these greenfield projects. By way of example, AEMO, who is the transmission planner in Victoria, is currently running a competitive tender for a proposed circa $500 million expansion of the transmission grid in Western Victoria. The contestable process will deliver a negotiated 30-year tariff that is likely to provide a return in the high single digits to low double-digit range for the greenfield project. Of course, the disconnect is that the current RORG for a regulated contingent project such as EnergyConnect will, in theory, deliver a return of approximately 4.6%. And of course, with the way that the regulatory model deals with low inflation, the actual delivered return would likely be closer to 4%. This would obviously be an uncommercial and unsustainable outcome and one that we are attempting to address with the regulator and other stakeholders. What we can't afford is for the inflexible regulatory processes to stymie investment in these projects which are urgently needed in the grid for the benefit of consumers.

Just quickly looking at Project EnergyConnect on Slide 21, the proposed new 330 kV interconnector between New South Wales and South Australia, now known as Project EnergyConnect. This would be delivered by TransGrid in partnership with ElectraNet between Robertstown in South Australia and Wagga Wagga in New South Wales. If approved, the project is expected to deliver net market benefits of approximately $900 million over 21 years in present value terms. Final costs are not yet known but are likely to be in the region of $1.5 billion. Up until recently, ElectraNet has been progressing and driving the project as required, but it has now reached the point where TransGrid can now begin to commence its contingent project application under the rules.

Slide 22. And I've really addressed this slide before in acknowledging that while the current focus is on transmission networks, distribution networks will play an accelerating role in the future in relation to the way electricity is generated, distributed and managed to maintain reliability and grid stability.

So moving on to and concluding with strategy and outlook. Slide 24 deals with strategy. You've seen this slide again a couple of times now. Our vision is to create long-term value through capital growth and distribution for securityholders from a portfolio of high-quality, long-life essential services infrastructure businesses. This is unchanged. We are also committed to the new energy future and to leading energy transformation in Australia. Our objective is to lead the sustainable reduction in emissions through investing in renewable generation and complementary and smart electricity grid infrastructure. We will continue to focus on efficient operations and investment, which we call Value Enhance, and also the disciplined pursuit of brownfield acquisition opportunities, which we call Value Acquire. These remain unchanged as well.

We recognize that pressure will remain on regulated returns in our network businesses over the next regulatory period. Accordingly, we are also prepared to review opportunities in the evolving landscape for accretive growth by acquiring and building businesses and platforms in the adjacent asset classes. This is our Value Build strategy. We're seeing the first step in execution of this strategy with the acquisition of the Bomen Solar Farm, which has now commenced construction, and is expected to deliver returns in excess of the regulatory environment. We continue to look at further opportunities as we seek to develop a business platform focused on renewable energy and new technologies but are disciplined in this pursuit, recognizing the risk that currently exists.

And on outlook and distributions, Slide 25. The directors have reaffirmed distribution guidance for 2019 of at least $0.15 per security subject to business conditions and have reactivated the DRP for the September distribution at a 2% discount. A reminder that when we reduced our distribution from $0.16 to $0.15 per security for 2019, we did so on the basis of the federal court decision in February and the expectation of paying tax earlier than anticipated and not for any other reason. This was a disappointing and unexpected decision, and VPN has subsequently appealed both matters to the full federal court. The hearing for this has been unfortunately delayed and is not expected to be heard until February next year, 2020.

Accordingly, we felt it appropriate and prudent at the time to ensure we could fund the tax payments from operating cash, and our distributions would be fully funded from operating cash flows after tax payments. We have paid $16.9 million in tax in relation to the 2018 full year, which translates closely to the 6% effective tax paid rate that we've previously disclosed and equates to the $0.01 per security reduction in distributions. Of course, we expect to be able to distribute franking credits in due course but cannot do so until the court appeal is heard and the tax matters have been finally resolved.

Assuming that tax matters are not overturned on appeal, we continue to expect that the effective tax payment rate based on stand-alone net operating cash flow will be approximately 12% next year, growing to 20% in 2 years. There's no change to this expectation.

Looking forward, as previously stated, we expect the distributions to securityholders will align more closely with the 5-year regulatory periods of our major investments, being SAPN and VPN. The impact of the new RORG and lower inflation will negatively impact regulatory returns for the upcoming 5-year regulatory periods of SAPN and VPN in the absence of any change. We continue to lobby relevant stakeholders that the RORG has already become outdated and unsustainable in the current low inflation and interest rate environment and volatile market and risks adversely impacting the operations of the business and the provision of essential services to electricity consumers. This disconnect is even more obvious as many billions of dollars of investment is being called for in new critical pieces of transmission infrastructure to support the energy security and reliability needs as more renewable generation connects into the energy system.

Taking into account these regulatory and macroeconomic headwinds and notwithstanding the best efforts of our investment businesses to mitigate these impacts, the directors expect distributions to securityholders will need to rebase to a lower level for the next 5-year regulatory period. It is not possible to determine the impact on future distributions at this point given that the regulatory processes for SAPN and VPN are not final, relevant bond yields are not yet known, the final tax positions are not known and the capital investment requirements for the potential contingent projects in the TransGrid business cannot yet be determined.

And finally, for the record, Slide 26. This slide sets out the key dates for the distribution and the DRP.

And with that, I'll open up to questions (Operator Instructions). I'll hand back to the moderator now. So thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Ian Myles of Macquarie Group.

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Ian Myles, Macquarie Research - Analyst [2]

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Vegetation cost management, what's the budget for VPN for this year and maybe SAPN? And so you've obviously spent a lot in the first half. But how much is going to drop in the second?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [3]

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We're not disclosing the actual dollar figure associated with the budget. The budget remains consistent with that spent in 2018. Really, what you're seeing with the $19 million that's being spent is an acceleration of the cutting programs such that, in this half, more of the operating cost was incurred with obviously less in the second half. So I think on a full year basis, you're not going to see a particular difference when it comes to vegetation management.

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Ian Myles, Macquarie Research - Analyst [4]

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And are you going to pay that $60 million of tax in your tax paid or payable in your balance sheet this half? Or is that going to get deferred?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [5]

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We're in discussions with the ATO currently. The payment timing of that remains unclear, but we would expect it to be in the next 6 or 12 months.

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Operator [6]

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Our next question comes from Rob Koh of Morgan Stanley.

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Robert Koh, Morgan Stanley, Research Division - VP [7]

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And on a personal note, Nick, we barely knew you, wish you well with your next opportunity. So my question, I guess, relates to your -- how the teams are managing the lower -- or lower base for distributions once the next resets come through. You've been very transparent about that. Can you give us like an order of priority about the levers that the businesses are using? Presumably, the interest rate hedge books will allow for lower refinancing costs. Can you comment on more gearing, less CapEx, these kind of levers, please?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [8]

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Yes. Thanks, Rob, and thanks for your interest in Nick. I much appreciate it. Look, the businesses will review all aspects of their response to the lower environment. I mean obviously, the RORG and, hence, the impact on the next regulatory period is for 5 years, so what it turns out to be post that 5 years is anyone's guess. And hence, the responses that the businesses will look at will be very much focused on how do we get through the next 5-year period.

I think what Nick is trying to make clear to yourselves that we -- the capital books, if you like, are in a very strong position with the gearing, net debt to RAB, that mid sort of 70s level, that's a great place to be in. That's not necessarily going to be the most important constraint on the business because, as we've previously indicated, we're moving to -- we're not moving -- but what's becoming more prevalent is the FFO to debt metric.

So the businesses will take that on board. They'll look at their CapEx programs. They'll look at their OpEx programs. They need to ensure and maintain the networks such that they operate as reliably as possible. But they will be very judicious in the way that they look at the CapEx and OpEx going forward.

So there's not one lever. The point of the businesses are that they are the most efficient businesses in the NEM and amongst their peers obviously. So that's a great place to be, and I'd rather be in that position than anywhere else. But they will certainly look at the whole of business and how they can respond across that next 5-year period. So doesn't -- probably doesn't provide you with any particular golden egg solution, but we will certainly look at it as how do we get across the next 5-year period under this -- under the rate of return as it's looking to appear in front of us.

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Robert Koh, Morgan Stanley, Research Division - VP [9]

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Yes. Okay. Just for more a modeling question. I guess if we look at the OpEx results for SAPN and VPN for this half, and there are obviously all those adjustments that you've called out, the noncash ones, do -- is those adjusted OpEx numbers what goes into the reviewed OpEx is? Or is it the actual numbers that you've reported?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [10]

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It's a good question. I wouldn't expect that the regulator would take into account, for example, the noncash movement in employee long service leave and annual leave balances. That is purely a sort of DCF exercise. And -- or what's caused that movement has been a DCF exercise and the change in bond yields. So I would expect that they would look through that to the more sustainable OpEx run rate. I might inquire internally, but that would be my reaction.

And Rob, just while I got the microphone, I just wanted to add something on Ian's question a minute ago about tax paid. On that tax payment, so you're talking about the tax paid effectively for the periods leading up to 2017. As you would know, we are engaging around the South Australian partners -- partnership and our sales partnership companies. We haven't received that amended assessments. We're in discussion with the ATO. But often, what can transpire in these types of situations, is that you come up with a negotiated amount. So it may well be that you pay half, for example, to ensure that things like penalties and whatever are stopped if that's relevant.

So again, we have reached out to the ATO. We're a good taxpaying citizen in that regard, and we've actually reached out to them prospectively and are looking to engage with them because obviously the decision that was made, was coming out, was in relation to VPN and has not been read over to South Australia in their amended assessments at this point. So there's still some uncertainty there in terms of what is agreed and what is paid and the timing thereof, so just a little bit more confusion for you.

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Operator [11]

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(Operator Instructions) Our next question is a follow-up from Ian Myles of Macquarie Group.

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Ian Myles, Macquarie Research - Analyst [12]

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Just -- you made a comment about the interconnectors and the very low returns you're potentially receiving. Is there any potential that you'll just go on an investment strike and actually not build them?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [13]

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Ian, yes, there is. That's -- I guess that's the position of last resort. But I think we're sitting here, unless there is some type of change to the regulatory system which will provide us with an equity return of, say, 4%, and that's a 4% return with all the other risks inherent in major construction project -- and all you have to do is look around the major construction projects and know that there are very, very significant risks. This is not an immaterial business as usual, small CapEx addition which you can manage within your bigger CapEx budget. This is a significant major piece of expenditure with all sorts of greenfield risks.

That's the real challenge in front of us, Ian. And I can put it back to you and say, well, would you invest at 4% and take in all the risks. And that's what we're trying to defend because it is not fit-for-purpose the current regulatory framework and the RIT-T process.

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Ian Myles, Macquarie Research - Analyst [14]

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Under the RIT-T, if you were to get your separate return, I presume the economics which they have been doing the RIT-T on would shift dramatically, and would this project actually be justified?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [15]

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Well, that's something that the regulator looks at in doing the RIT-T.

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Ian Myles, Macquarie Research - Analyst [16]

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Well, you guys presented -- or is it -- or ElectraNet presented the RIT-T, so that would have chosen the assumptions?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [17]

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Yes. Well, so I'll let you know if we're going down that process. It's ticked off the initial boxes. This is the dilemma that the industry is in. We're in uncharted territory here. So there is a need, and everyone understands commercially the need, and it's been codified, if you like, through the Integrated System Plan. It's like, well, how do we bring that Integrated System Plan to life?

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Ian Myles, Macquarie Research - Analyst [18]

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I guess if you don't build it, could someone else step in and build it?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [19]

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That's challenging. And it's not actually currently permitted within New South Wales, but that is the situation in Victoria. And as I've said, the example that I gave is that AEMO is running a very large contestable build-out in Western Victoria transmission project. That's like a $500 million project that I spoke about before. So it is a contestable process in Victoria because AEMO's effectively the transmission planner. And they put that out to tender, and they bring in some -- they may well bring in someone else.

I mean, to me, it's logical. But it would be a major transmission company, such as AusNet or ourselves, that would be building that. But it's been at a different rate, and it's a negotiated tariff. So the point to bring out there is negotiated tariff. It is outside the regulatory system. Anyone that's going to come in and take on that risk for a newbuild like that is not going to be doing it for 4%. So that's the dilemma in front of us. These are -- it's uncharted what we're doing here, what the industry is facing. It's not just us, it's the whole industry that's facing it. And obviously, we've got AEMO with their Integrated System Plan, identifying the need. You've heard from the CEO, Audrey Zibelman, come out and sort of saying we can't slow this down. We know we've got risks about blackouts, and we need this.

If you look more deeply in the results, you'll see that the CapEx or the unregulated CapEx in the TransGrid business in the previous half was slow. It's built up in this current half, which is dealing with a bit of a backlog that resulted through delayed connections, which is all part of the same issue. So it is really challenging times. And the regulatory framework, all the regulator does is just run the ruler over the existing regulatory framework. So it doesn't offer -- it doesn't provide a view on policy, and that's the challenge. So that's why we now are engaging with many of these other stakeholders that we have to be flexible to deal with what's ahead of us. If you want us to make the time line -- we want to spend the money, don't get me wrong, Ian, but I've got to look to you guys and our investors to ensure that we get an appropriate rate of return for the risks that are involved in the construction.

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Ian Myles, Macquarie Research - Analyst [20]

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Yes. Okay. And one question on Bomen. You have a derivative, call it, $5 million gain. Should we interpret that the electricity price in your assumption has now gone down against what your hedge is or what your PPA is?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [21]

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No, I don't think you should interpret it that way. I mean firstly, the valuation of derivatives, as you probably know, for accounting purposes, is a reasonably complicated exercise. But obviously, if the -- if there's an asset value that's there or value created through that derivative, you would think that the price received is -- may be better than projections that the auditors are comfortable with.

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Ian Myles, Macquarie Research - Analyst [22]

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Yes. Okay. So is this about the PPA, the NPVs, the PPA relative to your projected prices?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [23]

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Yes.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [24]

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I mean it is, Ian.

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Ian Myles, Macquarie Research - Analyst [25]

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That's cool. That's all I need to clarify.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [26]

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I don't know if I get overly excited or read too much into that position relative to sort of long-run Bomen sort of valuations.

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Ian Myles, Macquarie Research - Analyst [27]

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Oh, no. It's more just -- it's a noncash item. It's a bit like a fair value adjustment for power companies we sort of ignore till it becomes cash.

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Nicholas Schiffer, Spark Infrastructure Group - CFO [28]

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Correct. I would agree with that.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [29]

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Yes. And that's why we've pulled out of, what we call, the adjusted results because it's a noncash, it's not real until cash starts coming in the door.

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Operator [30]

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Our next question comes from Nathan Lead of Morgans Financial.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [31]

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Rick and Nick, just a couple of quick ones for me if I could on just the 1H. But first off, you've got that chart in there on Slide 33, repeating once again what the impact of the rate of return guidelines and tax is. But can you have a bit of a stab first about what the impacts on revenues would be if you were to run current risk-free rates down?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [32]

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Thanks, Nathan. No, we won't. You just can't do it. We've outlined there the prima facie income -- sorry, impacts from the parameters that are in the RORG. There are too many other moving parts and goes back to the question that was asked earlier about -- in around the response to come from the businesses. So yes, there will be a reduction in the headline number. I don't know what bond rates are going to be in due course whenever they're set. I don't know if things will change. I mean we are arguing that the RORG is completely outdated already. So I think it's wrong to try and jump to some type of worst-case scenario, and I -- because I don't know what that is. And then the challenge is then passed to the businesses in terms of how do they respond within -- particularly within the 5-year period. So I think it's dangerous and misleading, and all I'll do is give you a wrong number.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [33]

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Yes. Okay. Second one for me is, obviously, with tax starting to be paid, can you just talk about the ability to stream the franking credits out to your investors, what the restrictions are in the structures?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [34]

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We don't see any current restrictions in the structure, Nathan. So the current restriction is basically that we need the tax matters resolved, and then the franking will follow. But we don't see any bottlenecks within the existing structure.

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Operator [35]

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Our next question comes from James Nevin of RBC.

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James Nevin, RBC Capital Markets, LLC, Research Division - Senior Associate [36]

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Rick and Nick, I was just hoping to potentially get an update on just operating cost in some of the businesses, so like VPN and SAPN. So ahead of those operating costs, how much of that is -- what kind of performance you're kind of getting on the regulated side? And are you able to give some sort of indication on the kind of semi-regulated and unregulated revenues and kind of the margins that you earned on those? Obviously, you gave the Enerven and Beon margins. I'll just say, you have the operating cost split here for TransGrid in regulated and unregulated, just to be able to give something like that for SAPN and VPN.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [37]

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So James, let me just take the first question, and then Nick might add something. But in terms of talking about the outperformance, no, we're -- I'm not going to provide any numbers there. They are -- the businesses are operating to budget. And philosophically the budgets that we set are challenging for the business. So you can read through that, that they are incentivized to outperform. The challenge is that you're looking at a 6-month period, and we view the businesses over a 5-year period. So there may well be ups and downs within the 5-year period. So vegetation management is the classic in this particular set of results. So there's an acceleration there of programs and we've -- the variances is negative obviously in comparison to the previous half. But as Nick has said, the -- we are on track to effectively be a consistent sort of vegetation management cost year-on-year. But overall, we do target sort of that low double-digit sort of outperformance on OpEx and sort of CapEx. So that is the overall target that we look to achieve over the 5-year period. And we are not that comfortable with that target.

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Nicholas Schiffer, Spark Infrastructure Group - CFO [38]

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So in relation to the other sort of unregulated or semi-regulated line items, we don't provide margins or we don't go into granularity around costs. I think maybe the way that you could form your own view would be if you look at sort of regulatory determinations and other regulatory disclosures, you could probably get a better feel for the regulated operating costs and then sort of back into the nonregulated operating cost piece. But we don't provide that granularity.

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James Nevin, RBC Capital Markets, LLC, Research Division - Senior Associate [39]

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Okay. And then just on SA Power Networks, just hoping to -- the recent kind of SA Water deal that you announced, is that flowing through in the current results? And has that started earning revenue on that contract?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [40]

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Yes, it has started. So I'm just looking in the appendix, I don't think it's disclosed in there. But the numbers right now are very, very modest. They'll be -- they'll have more impact in the second half of the year.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [41]

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So James, on Slide 37, unregulated revenues. The energy infrastructure revenue line is fairly flat, a little bit down. I mean there's reduced ElectraNet revenues from the provision of services to ElectraNet in there but has been offset by a little bit of the ramp-up coming through from the SA Water contract. So it's done in pieces. It's like an umbrella agreement. And they bundled together a package, and then that comes to us and we work through that. So we will build up as little bit of early revenues come through it to assist in the establishment of the umbrella agreement, if you like, but it's still quite sort of early days.

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Operator [42]

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(Operator Instructions) Our next question is a follow-up from Nathan Lead of Morgans Financial.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [43]

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I just wanted to ask about just the subordinated debt pay-down at VPN and what your thought as you going into sort of taxpaying status, you want to hold on as much just your interest tax shield as you could. Just wondering what the strategy is there and whether that pay down is going to continue?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [44]

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Look, the expectation is that the pay-down probably won't continue. And no, I won't comment around the tax shield aspects. But there's obviously a variety of commercial drivers that I think the conclusion is that it won't be paid down going forward.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [45]

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I mean as well the tax shield.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [46]

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Yes, it does. It does. And VPN itself, as you know, is transitioning into tax payments. So it's something that the owners, of which we are one obviously, look at in terms of how best that would be structured going forward. So to the extent there our franking credits that are being generated in VPN, we don't want that to be held as a bottleneck. So the composition is actively under review if you like.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [47]

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Okay. And guys, just as while I've got you, can you just give an update if it's changed at all, the FFO to debt targets, for each of the different asset companies?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [48]

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Look, over the medium term, the targets -- well, maybe a better way to put it, the -- in the current rating bands, it's circa 10% to 11%. I'm not suggesting that's necessarily a target, but that's where the current sort of rating band kind of leads you.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [49]

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And for TransGrid, it would be a lower number, I would have thought?

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [50]

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Yes. TransGrid, absolutely. So TransGrid will probably remain pretty consistent.

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Nathan Lead, Morgans Financial Limited, Research Division - Senior Analyst [51]

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With where it is now?

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Nicholas Schiffer, Spark Infrastructure Group - CFO [52]

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Right.

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Operator [53]

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There are no further questions at this time. I will now hand back to Mr. Francis for closing remarks.

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Richard F. Francis, Spark Infrastructure Group - MD, CEO & Executive Director [54]

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Thanks, Nicole. And look, thank you very much for your attendance today. We really do appreciate it. We will be available for any follow-up questions that you may well have. So again, we thank you very much. And on a personal note, Nick, good luck in your next endeavors. We really appreciate what you've contributed to Spark over the last couple of years. So thank you, all. And thanks, Nick. Cheers.

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Operator [55]

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That does conclude our conference for today. Thank you for participating. You may now disconnect.