AGL Energy: Time to rethink risk

About the author:

Author name:

By Max Vickerson

Job title:

Analyst

Date posted:

10 February 2023, 9:00 AM

Sectors Covered:

Industrials, New Energy

• AGL Energy's (ASX:AGL) 1H result was a significant miss on consensus and our forecast and FY23 underlying net profit guidance was reduced by $20m.
• We still expect earnings to rise in the next couple of years but we also increase our WACC to 7.7%.
• We maintain our HOLD rating with potential 12-month TSR of 5%.

Watch

Big 1H miss but only a moderate cut to FY23 guidance

Underlying net profit was down 55% on pcp, 60% on our forecast and 45% on Visible Alpha consensus. The key driver was a net $123m impact on the wholesale trading business from the tight winter conditions earlier in the half. This also drove a big miss on DPS with an interim dividend of only 8cps.

The top end of FY23 guidance was cut, reducing the mid-point of Underlying net profit guidance by 8% to $240m.

The only way is up?

The price shock that hit the electricity futures market over winter and drove the market to unprecedented highs will still drive an earnings recovery across FY24 - FY25. Retail tariffs will need to be increased significantly to account for the higher cost of hedging that retailers had to absorb.

The challenge for the market is how to appropriately price the risk of further government intervention and the reliability of the generation fleet. Winter in 2022 was an extraordinary time but with the market in transition and an ageing coal fleet across the NEM, it’s not inconceivable that supply shocks could happen again.

We have lifted our assumed cost of equity to 9.5% (+50bps) to better price this in.

Forecast and valuation update

We have lowered our forecast for earnings across FY24 - FY25 to explicitly price in the risk that there will be intense pressure on the industry to limit increases in electricity tariffs.

We’ve also reduced forecast operating cash flow for FY23 as a result of the weak cash conversion due to margin calls in the last half. We expect some of this will unwind this half. We also anticipate lower cash tax payments as a result of the large statutory loss from generation asset write downs.

The net effect, along with the higher discount rate is a reduction in our valuation and target price to (login to view).

Investment view

We anticipate increasing dividends as earnings begin to recover in the next 12 months however we think the market will want to see clear evidence of this before it regains confidence in the company and the sector.

We maintain our HOLD rating with potential 12-month TSR of 5% made up of a 9% forecast dividend yield (final FY23 + interim FY24) and a -3% forecast capital return.

Price catalysts

Draft DMO for FY24 to be released on week beginning 13 March and the final determination will be issued by 26 May 2023.

Full year financial result released in early August, potentially with guidance for FY24.

Risks

• Performance of the generation fleet.
• Commodity prices (coal, gas, electricity and carbon), interest rates and tax regimes. 
• Capital investment into new generation. 
• Market regulation.

Find out more

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