AGL Energy: Going for a trial separation first

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Max Vickerson
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By Max Vickerson
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Date posted:
30 March 2021, 3:20 PM
Sectors Covered:
Industrials, New Energy

  • AGL is investigating splitting into separate retail and generation focused businesses.
  • ‘New AGL’ will focus on retail and will be Scope 1 and 2 carbon neutral from creation while ‘PrimeCo’ will hold the legacy thermal assets.
  • An offtake contract will be struck between the two entities.
  • The company has not updated its earnings guidance and conditions remain weak.
  • We maintain our HOLD rating but reduce our target price (login to view).

Internal split first with formal move detailed at the end of FY21

AGL is proceeding with splitting its legacy generation business from its retail business. The exact structure is not yet clear but in broad strokes all of the coal and thermal baseload will move to an entity called ‘PrimeCo’ while ‘New AGL’ will be a multi-product retailer (electricity, gas, broadband, phone). Management stressed this will be an internal only split for now until key details are worked out. The company intends to unveil the details of the demerger by the end of the financial year.

Zero sum game or is there value to be unlocked?

At the interim result we thought it likely that if AGL wanted to split it would need to tie its two businesses together through an offtake agreement. The company has not locked in an arrangement yet and we see this as being a crucial piece to determine the value of each entity. We think that at current futures prices AGL’s generation fleet cannot cover both short run costs (fuel and minor maintenance) along with fixed operating costs and medium term sustaining capital expenditure. While there are opportunities to drive costs down, New AGL may need to effectively transfer value to Prime by underwriting its offtake for a period of time. On the other hand a number of low carbon listed retailers in NZ trade on much higher earnings multiples than AGL. It’s possible that New AGL may rerate higher but there are key differences between the Australian and NZ electricity markets.

Electricity market weakness continues to weigh

AGL has not updated its guidance for FY21 earnings and it noted that the weak electricity market conditions it has called out in the past still persist. The draft Default Market Offer (DMO) prices for eastern states other than Victoria are softer for FY22 and futures prices continue to drift sideways well below the levels of FY19. We have lowered our forecast for FY22 earnings on electricity weakness and increased our forecast for capital expenditure.

Investment view

We think AGL’s strategy to carve out the carbon intensive parts of the business makes sense. We see upside potential for New AGL if it can rerate towards the P/E multiples of the NZ integrated retailers like Mercury and Meridian. However we think the devil will be in the detail of how much Prime will need to lean on New AGL before it can be self-sustaining. In the short term we think that Australia’s electricity market weakness will continue to dominate the earnings profile of both parts of the business so we’re comfortable maintaining our HOLD rating but with a reduced price target of $9.74ps.

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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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