EUR 850.00 For Business Accounts Only

Morningstar | Maintaining AGL’s AUD 21 FVE Despite Headwinds

We reduce our medium-term earnings forecasts for narrow-moat-rated AGL Energy but remain comfortable with our AUD 21 fair value estimate. At current prices, the stock is fairly valued. While earnings growth is increasingly unlikely in coming years, AGL generates strong free cash flows and has a conservative balance sheet. As such, it is well positioned to pay generous, mostly franked dividends and invest large sums into new electricity generation and storage equipment, improved IT systems and possibly even acquiring a complementary business.

At the recent Macquarie conference, management cited four negatives for fiscal 2020 and no positives. That doesn’t mean there aren’t any positives, but it’s probably a sign that fiscal 2020 consensus analyst expectations for NPAT of AUD 1020 million is too high. We reduce our fiscal 2020 NPAT forecast from AUD 993 million to AUD 953 million and reduce forecasts in subsequent years by similar amounts. Our fiscal 2019 forecast is largely unchanged, with management guidance of AUD 970 million to AUD 1,070 million reconfirmed.

The fiscal 2020 negatives are falling renewable energy certificate prices, lower wholesale electricity prices as new generation supply is built, higher coal and gas costs as some cheap long-term contracts end, and retail price caps following regulatory reviews. These issues are widely known, but it is difficult to estimate their earnings impact. These factors are also likely to weigh on earnings in subsequent years.

In addition to the above negative factors, earnings from 2022 will be hurt by closure of AGL’s large, low-cost, coal-fired Liddell power station. This will reduce the firm’s generation output by up to 18%, all else being equal. However, we expect the financial impact to be partly offset by higher wholesale electricity prices, given Liddell’s closure will remove a substantial amount of baseload power supply from the grid.

AGL is transitioning to a more flexible electricity generator. While necessary, it’s hard to see how the future mix of assets will be as profitable as the old coal-fired power stations. Focus is on investment in gas-fired peaking power stations and supporting infrastructure, such as import terminals and storage facilities, to “firm” intermittent renewable energy. Management also sees opportunities in residential batteries and will offer these from July 2019. Despite being slower off the mark than some peers, AGL hopes to gain an “out-size” market share.

Residential batteries aren’t economic in their own right, but new government subsidies should increase their popularity, particularly for houses with solar panels. The Australian Energy Market Operator forecasts up to 200,000 residential batteries will be installed by 2025. Investment in large-scale battery farms and pumped hydro is also likely.

These assets are expensive to build and only supply electricity for short periods of time, requiring high wholesale prices to make reasonable returns.