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The Wrap: Utilities, LNG/AUD & Infrastructure

Weekly Reports | Oct 20 2017

Weekly Broker Wrap: Utilities; LNG & AUD; consumer; infrastructure; Afterpay Touch; and agricultural stocks.

-National Energy Guarantee envisaged supporting incumbents
-LNG becoming more significant in Australian dollar valuation
-Energy costs seen becoming a problem for supermarkets
-East coast infrastructure boom gathering pace
-Improving conditions for agricultural stocks


By Eva Brocklehurst


Australia's government has released its energy policy, called the National Energy Guarantee. This has two components: reliability, which requires retailers and large users to procure a certain percentage of electricity from generators that meet dispatchability criteria; and an emissions guarantee which requires retailers and large users to procure a certain percentage from lower emission generators to meet emissions targets.

The renewable energy target (RET) remains in effect but will not be extended beyond 2020. If the policy is endorsed by the Council Of Australian Government (COAG) meeting in November the reliability guarantee will start in 2019 and the emissions guarantee in 2020.

Ord Minnett suspects the policy is shifting the burden of meeting guarantees onto the retailers and could lead to market distortions with added power to the incumbents, namely AGL Energy ((AGL)), Origin Energy ((ORG)) and Energy Australia. Moreover, wholesale prices are considered still too low to encourage investment in new generation assets. The broker believes the policy will encourage retailers to own generation assets.

UBS believes the new generation that is required to bring down prices should benefit incumbent producers. At this stage the broker envisages no short-medium term impact on wholesale electricity prices. The move to a contract-based system may benefit AGL Energy and Origin Energy in the medium term.

The broker expects east coast electricity prices will remain at or above $80/megawatt-hour for the next three years and gas prices will be in the $8-10/gigajoule range for the foreseeable future.

Morgan Stanley believes, if implemented, bipartisan policy would be a positive for all utilities under coverage and the emphasis on contracting is a net positive for AGL Energy and Origin Energy.


Commonwealth Bank analysts observe a change in the driver of Australia's terms of trade appears to be occurring. A common tool in estimating the terms of trade has been the iron ore price. Iron ore is Australia's largest export so its price should have an influence on the Australian dollar. The iron ore price has trended lower so far this year, to around US$60 a tonne, currently, while in contrast the Australian dollar has trended higher, to around US78.5c.

Hence, the analysts question the influence of iron ore price on the Australian dollar and suggests the ongoing recovery in LNG prices is emerging as part of the story that supports the Australian dollar. The LNG price has increased by 45% since a cyclical low point in May 2016.

The analysts note a decade-long mining investment boom has increased the capacity in Australia to extract gas and estimate that oil & gas production will approach iron ore in the next few years. While iron ore will remain an important influence on the Australian dollar the analysts believe it's important to be aware of the changing trends in LNG and oil prices.

Most of Australia's current and future LNG is exported to Japan and Korea. China will take about 20% once full production is reached in coming years. In general, the price of LNG production occurs under long-term contracts linked to the lagged price of Brent crude oil and therefore fluctuations in the Brent price will affect the fundamental valuation of the Australian dollar.


Morgan Stanley suggests, having met with a number of industry contacts, the trading performance of Coles ((WES)) and Woolworths ((WOW)) has improved. Suppliers are consistent in their feedback that execution at Woolworths is stronger than Coles, which is suffering from higher rates of staff turnover.

Energy costs appear to be fast becoming a problem, with the broker noting some suppliers have indicated as much as 100% increases from early 2018. Suppliers also indicated promotional intensity has increased, with promotions now often required to support new product development.

Meanwhile, a major supplier to Metcash ((MTS)) has shifted its distribution to independents via a competing wholesaler. Morgan Stanley estimates the sales impact for Metcash is around -$70m on an annualised basis. The company remains confident that supplier additions will more than offset the supplier losses.


Over the next four years both the Australian government and the states are expected to spend around $237bn on infrastructure. Macquarie suggests the amount may be at least $323bn, as planning advances on major projects that have not yet received full funding. The broker notes and NSW and Victoria plan to spend $73bn each by pumping property tax revenue from the Sydney and Melbourne property markets and their own recycled infrastructure into new projects.

In anticipation of another wave of asset-rich Sydneysiders moving north, the broker suggests Queensland could eventually join the boom. The Sydney and Melbourne housing markets and political momentum in asset recycling appears to be the key source of infrastructure funding for some time. Meanwhile, roads and rail have near-record levels of work in hand and other areas such as water and sewerage and electricity are coming on board.

Aged care has also record levels of work in hand. Macquarie estimates that weakness in housing over the next two years will be offset just by the work that has already started on roads, and other sectors and roadwork will easily cover the risk of a sharper housing downturn, if realised. Nevertheless, the infrastructure boom is unlikely to overturn the benchmark created by the heights of the mining boom between 2005 and 2013.

Afterpay Touch

Afterpay Touch ((APT)) provided a strong quarterly update with the numbers coming in ahead of Bell Potter's expectations. There's been a significant increase in the number of merchants offering Afterpay, up 43%, as the benefits of the payment method become more apparent.

The company has flagged a possible New Zealand dollar bank facility to support business expansion in New Zealand. The broker considers this a positive development and looks forward to hearing news regarding other international markets the company may be targeting.

Bell Potter upgrades underlying estimates of earnings per share by 4.0% and 9.3% for FY18 and FY19 respectively. Earnings revisions are driven by higher customer numbers and higher expenditure, offset to some degree by higher cost growth estimates. The broker upgrades the price target to $7.30 from $5.90 and retains a Buy rating.

Agricultural Stocks

Rainfall across large parts of Queensland and New South Wales and a partial recovery in cattle prices have supported Ruralco ((RHL)) and Elders ((ELD)) in recent weeks. Wilsons observes the rainfall represents a timely seasonal break for the summer cropping activity.

The broker remains broadly comfortable with estimates for 2017, given Elders guidance appears conservative and Ruralco provided guidance in July, which likely reflected the more subdued trading consider conditions experienced during winter.

While the cattle price (Eastern Young Cattle Indicator) has bounced from its lows it remains around -10% below the global price. This reflects the lingering impact of dry weather. Wilsons expects, given the outlook for average rainfall over the next three months, that the gap should close, all else being equal.

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