AGL Energy: Resilience in troubled times

About the author:

Max Vickerson
Author name:
By Max Vickerson
Job title:
Analyst
Date posted:
16 March 2020, 12:30 PM
Sectors Covered:
Industrials, New Energy

  • AGL has fallen 19% from its post reporting season high in the midst of the broader market selloff on concerns over the corona virus.
  • We see electricity demand remaining resilient in the second half even if there are interruptions to economic activity. AGL carries minimal exposure to the spot price as customer demand is well matched by generation output.
  • AGL retains a strong balance sheet and is likely to generate strong cash flows.
  • We upgrade our recommendation to ADD and adjust our target price (login to view) with potential 12-month TSR of 13%.

Resilient electricity demand

In the midst of concerns over the economy it’s worthwhile remembering how inelastic electricity demand can be. We’ve looked at historical demand over the last three years on Anzac day compared to the monthly average for April across the NEM and we find that demand can be up to 10% lower. If that drop in demand is representative of a potential drop while schools and businesses are shut we think the impact will be minimal. Assuming a four week shutdown across April would mean an impact of only ~2% in aggregate across the second half of the year. We have taken a conservative approach by lowering retail and business customer demand by 5% in 2H20 and FY21.

Hedged against spot prices

AGL’s aggregate generation output is very well matched with its total customer demand. There is still some residual exposure to spot prices as generation does exceed customer demand in some states and there are shortfalls in others but on average the variances will largely balance out. AGL’s profits within the current half will be more influenced by the cost of fuel for its generators and the prices charged to its customers which are both stable in the short term. While long term headwinds still face the sector, we think the desire for protection from equity market volatility will outweigh the problems the electricity market might face in FY21.

Balance sheet strength and solid cash flow

AGL’s interim accounts showed net gearing (defined as net debt divided by the sum of net debt and equity) of only 26%. We don’t see any significant threat to AGL’s credit rating because of its low gearing and stable earnings. AGL also generated strong cash flow in the first half, partly as a result of falling electricity futures prices. We see this trend continuing to play out in the second half as futures prices have fallen further since the half year result. We have confidence in AGL’s ability to continue to pay dividends at 75% of its underlying net profit for the foreseeable future.

Investment view

Following the sharp falls in AGL’s share price over recent weeks we see the stock trading below fair value. We’re confident that significant downward shocks to earnings are unlikely which will make AGL an attractive investment in turbulent times. With the dividend yield at nearly 6% (franked at 80%) and 7% upside to our target price we estimate there is the potential for 12-month total shareholder returns of 13%. We upgrade our recommendation to ADD accordingly.

More information

Morgans clients can login to view our detailed report on AGL Energy. Alternatively, please contact your Morgans adviser or nearest Morgans office for access.

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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