AGL Energy: Struggling to see a turnaround

About the author:

Max Vickerson
Author name:
By Max Vickerson
Job title:
Analyst
Date posted:
13 August 2021, 9:00 AM
Sectors Covered:
Industrials, New Energy

  • FY21 underlying EPS of 86.2cps was in-line with expectations.
  • FY22 guidance for underlying NPAT of $220m - $340m fell significantly short of our expectations (-36%) and consensus (-17%).
  • We retain our HOLD rating and update our target price to (login to view).

Underlying earnings to fall by another 48% in FY22

 AGL’s earnings are expected to fall further this year as more profitable wholesale hedging contracts expire and retail margins remain under pressure. 

Growth in customer service numbers (+6% on FY21) has been impressive but a significant portion of this has been from acquisition of low margin telecommunications accounts or part of the Click Energy acquisition. 

Management highlighted the ongoing challenges facing baseload plants and suggested there will be limited participation in pool price upside in FY22 because of AGL’s contracted position.

Multiple issues in the medium term

We think AGL will face sustained fuel cost increases as its legacy black coal contracts continue to unwind which will keep pressure on earnings. 

Liddell’s closure in FY23 – FY24 will help lower sustaining capital expenditure however this comes at the cost of lower gross margins. We estimate that if its FY21 output was unhedged, it would have generated $190m in gross margin (~$29/MWh). 

In Q&A on the earnings call management pointed out that retail margins could need another 12-18 months before they bottom out but we think better than expected top-line growth could outweigh this. 

We expect competition for energy customers will increase in the long run with the entry of other utility companies such as Telstra into the electricity market and lower our expected long term Customer Markets EBIT by 5%.

Forecast and valuation update

We have lowered our FY22 earnings towards the lower range of guidance ($224m, -48%) with significantly lower Integrated Energy EBITDA being the main driver. We have increased our assumed medium term realised price at Loy Yang in-line with increases in Victorian futures contracts. Our Accel Energy valuation, including the 20% cross ownership in AGL Australia, has lifted to $1.15ps (+$0.64).

Our AGL Australia valuation has fallen to $7.79ps because of weaker expected long run earnings and increased shares outstanding from the underwritten DRP.

Our overall valuation of AGL, as it is structured today pre-demerger, has increased marginally to (login to view).

Investment view

We think the majority of the potential downside is concentrated in the Accel Energy assets. We don’t see much value remaining in the combined value of those assets and we therefore think the downside is limited.

However, we continue to see only limited upside for AGL in the absence of a market redesigned to accommodate its legacy assets.

We therefore maintain our HOLD rating with 12-m potential TSR of 6%, including a 4% dividend yield.

Price catalysts

Demerger details to be released progressively ahead of a targeted 4Q22 implementation date. 

Victorian 2022 default offer draft price released September 2021.

Risks

Electricity, coal, gas and carbon prices.

Electricity market regulation.

Demerger arrangements including restructuring costs and debt ratings.

Interest rates and tax regimes.

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Disclaimer: The information contained in this report is provided to you by Morgans Financial Limited as general advice only, and is made without consideration of an individual's relevant personal circumstances. Morgans Financial Limited ABN 49 010 669 726, its related bodies corporate, directors and officers, employees, authorised representatives and agents (“Morgans”) do not accept any liability for any loss or damage arising from or in connection with any action taken or not taken on the basis of information contained in this report, or for any errors or omissions contained within. It is recommended that any persons who wish to act upon this report consult with their Morgans investment adviser before doing so.

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