Australia | Feb 17 2020
Despite downward pressure on electricity and gas prices, AGL Energy still has several positives in its outlook. None the least being customer retention.
-AGL Energy's customer gains/retention signal the benefits of incumbency
-Lower electricity pricing hampers development of new generation
-Current buyback program underpinning share price
By Eva Brocklehurst
AGL Energy ((AGL)) provided a pleasant surprise to brokers, delivering a first half result that was ahead of most expectations, despite underlying profit falling -20%. An outage at Loy Yang A unit 2 did not have the impact that was feared and costs are expected to be recouped in FY21 from insurance.
The company's Macquarie Generation (MacGen) coal supply chain provided better access to cheaper contracts, which should lift FY20 earnings. MacGen also offset the prolonged outage of Loy Yang A unit 2. Renewable generation was also higher which allowed AGL Energy to use less gas. FY20 earnings (EBIT) guidance has been reiterated at $780-860m, with a bias to the top end.
The company has acknowledged falling wholesale electricity prices and the re-pricing of legacy gas contracts will create headwinds. Renewables and cheap gas are putting downward pressure on electricity futures which in turn will put downward pressure on consumer electricity prices.
Wholesale electricity prices were ahead of Macquarie's estimates in the first half, reflecting additional generation at MacGen, a reduced need for gas and better spot prices. Yet, while these gains mitigate the impact of the outage at Loy Yang A unit 2 they do not prevent the impact of falling prices on overall profitability, the broker asserts.
As wholesale electricity prices are in backwardation (where the current price is higher than the forward price) and growth projects are uncertain, UBS expects earnings to decline by -8% over the next three years as the generation fleet realises lower pool revenue. Ord Minnett agrees backwardation has negative implications for future earnings while current wholesale electricity prices are unsustainably low.
Morgan Stanley estimates normalised underlying FY21 earnings per share could fall -5-12%. This is predicated on the non-recurring insurance recovery for Loy Yang A unit 2, which investors won't capitalise on, and the higher MacGen production rate, which investors shouldn't capitalise in view of potential displacement by wind and the closure of Liddell over FY22-23.
The company is also making progress on customer retention, although margin pressure continues. Macquarie points out the company is bucking the historical trend by winning customers as a fall in wholesale prices makes it harder for lower-tier operators that take on inventory to sell it.
Citi agrees the strength of incumbency is on show at AGL Energy and upgrades to Neutral from Sell. The company was able to build its customer base by taking share from smaller operators that are disadvantaged in a semi-regulated retail environment.
The cost to acquire and retain customers was reduced as churn declined to 15.7% from 17.6%. This suggests to UBS market competition may have eased. The increases in regulated pricing in Victoria and the draft decision in NSW suggest downside risk from regulated prices may be contained.
However, Macquarie suspects, with electricity prices coming off their highs, and volatility dropping with more supply, efforts by management to develop its strategy in new generation and gas imports are somewhat thwarted.