AGL Energy: Power market more important than structure
About the author:
- Author name:
- By Max Vickerson
- Job title:
- Date posted:
- 09 May 2022, 9:00 AM
- Sectors Covered:
- Industrials, New Energy
- AGL Energy’s (ASX:AGL) demerger scheme details were released Friday and our view of the company hasn’t significantly changed.
- We think the main advantage of demerger is a potential P/E multiple expansion of AGL Australia but this is not our base case and we don’t believe the market has priced this in. Therefore, we see limited downside if the demerger doesn’t proceed.
- We maintain our ADD rating given the strong wholesale electricity market which we think will significantly lift earnings for the legacy generation assets.
Demerger booklet sheds light on expected costs and capital structure
AGL has detailed the expected impacts of the demerger ($35m pa in additional corporate costs for Accel Energy, $125m present value of tax losses related to Loy Yang and $160m of additional trading collateral) in addition to the $260m in direct demerger costs (~$160m of this will be spent prior to the shareholder vote).
AGL Australia (AGLA) is expected to carry much higher net debt.
Based on FY21 EBITDA, AGLA would have had net debt / EBITDA of 4.1x vs 0.7x for Accel. Despite this AGLA is expected to have a Baa2 credit rating due to minimal need for sustaining capital.
Regardless of structure, the legacy assets look good in the medium term
The independent expert has highlighted that it’s possible for both potential companies to operate as two separate subsidiaries within the current AGL corporation with a similar arms-length offtake agreement to the current proposal.
Soaring futures prices in NSW and upwards pressure on VIC wholesale prices should lift the earnings derived from the legacy assets significantly in the next 12 – 18 months regardless of which entity they sit in.
AGL has highlighted the difficulty of managing risks in the retail customer book with baseload generation assets so we suspect that the company may already be looking to third parties for capacity contracts.
We therefore don’t foresee an immediate shock to the margins in the Customer Markets from the offtake agreement. However, there is the possibility of increased customer churn if retail tariffs move higher as per our expectations in FY23 - FY24.
Forecast and valuation update
Given the higher chance of the demerger failing with Mike Cannon-Brookes’ 11% stake we have not yet included the impact of the demerger. Equally we also do not include the potential for AGLA to trade on a higher P/E multiple.
We have split our expected Dec 22 net debt with similar proportions to the figures in AGL’s Dec 21 pro-forma balance sheets. We have also reduced our expected Customer Markets gross margin in later years by ~1% to allow for potentially higher churn.
The net impact is a slight decrease in our valuation to (login to view).
We still see tailwinds for AGL, particularly for the potential Accel business, given the tight conditions in the energy market.
We expect the impact on NSW and QLD to linger given the impact on coal prices from conflict in Ukraine and we see potential for VIC wholesale prices to move higher in future periods than the current financial market would suggest.
Given this, and despite the uncertainty from the demerger vote, we think the support for earnings growth gives us confidence to maintain our ADD rating.
- Retail pricing update from FY23 Final Default Market Offer released in May.
- Finalisation of the shareholder vote on 15 June.
- Return to service of Loy Yang Unit 2 on or before 1 August but equally a downside catalyst if this date slips.
- Commodity prices (gas, electricity, carbon).
- Performance and reliability of generation plant and costs to maintain.
- Interest rates and changes to tax regimes and energy markets regulation.
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