Accel Is A Hard Act To Sell For New AGL

Australia | Jul 02 2021

This story features AGL ENERGY LIMITED. For more info SHARE ANALYSIS: AGL

While AGL Energy’s split is supposed to set up both demerged entities for success, the jury’s out on whether funding provisions are adequate for both companies to pursue its growth ambitions.

-Greater clarity needed on dividend policies
-Brokers’ worry funding won’t support future growth
-Further earnings downgrades likely
-Debt refinancing flagged as key demerger constraint

By Mark Story

As far as embattled energy giant AGL Energy ((AGL)) is concerned the tilt towards renewable energy is very much a two-edged sword. Falling wholesale electricity prices, courtesy of renewable energy, are directly responsible for the company’s long awaited split

However, navigating the lurch to renewable energy will also play a major part in the company’s future.

AGL expects to complete the demerger by the end of FY22. Yet the demerger could be voted down at a future scheme meeting, given that 40% of AGL’s register is retail investors.

AGL’s eventual split into two will separate what’s euphemistically referred to as the “clean” bit.  AGL Australia will house the group’s electricity and gas retail business, the 20% stake in PowAR and the gas peaking assets.

Then there’s the “dirty” bit, Accel Energy (previously named PrimeCo). This will be home to the group’s coal assets including the Liddell, Bayswater and Loy Yang power stations, its Torrens Island gas plant and the legacy wind power purchase agreements.

Accel Energy’s new CEO Graeme Hunt, formerly AGL’s interim CEO, is tasked with managing the tricky transition from fossil fuels to a renewable future. Christine Corbett will be managing director and CEO of AGL Australia.

Greater clarity needed

With senior management appointments done and dusted, brokers want greater clarity on how the demerger can be done without compromising Australia’s east coast electricity networks baseload coal generation requirements in the process.

Much of analysts’ attention has refocused on balance sheet and capital raising issues. Brokers also want greater clarification around dividend policies and funding necessary both demerged entities to expand.

However, AGL has indicated that AGL Australia will retain a dividend policy based on underlying net profit. Meanwhile, Accel Energy will set a dividend policy based on free cash flow.

Having been unable to capture the benefit of the fourth quarter wholesale electricity spot price rally, AGL’s FY21 guidance was recently updated to the bottom half of prior earnings range of $1,585-1,845m. Net profit guidance is to midpoint of prior $500-580m range, both -4% below consensus.

The FY22 outlook is challenged with around $115m of favourable one-off items no longer in the company’s financials. While these events do not reoccur, Macquarie notes the outlook remains beholden to repricing for the forward book, the majority of which will be felt in FY22.

The broker has revised FY21 net profit down -1%, but increases FY22 and FY23 estimates by 2.5% and 8.7% to reflect higher forward prices. Due to research restrictions, Macquarie cannot advise its valuation on AGL at this time.

With consensus yet to fully factor in current headwinds, UBS sees a material earnings decline in FY22 -42% year-on-year. However, the broker lifts FY22-23 net profit forecasts modestly due to lower interest costs.

Funding issues

To ensure Accel Energy doesn’t exit the starting blocks with a too much lead in its saddlebags, there is a lot of talk around a practicalities of future capital raising. The company indicated Accel Energy will establish an $800m term loan, while AGL Australia will have a bilateral bank loan of $2bn.

UBS, which maintains a Sell and $7.60 target, believes the decision for Accel Energy to own a 15-20% equity interest in AGL Australia was necessary to support its credit metrics; especially given its volatile, declining earnings outlook.

Echoing a similar view, Ord Minnett believes Accel retaining 15–20% ownership of AGL Australia is a good way of having assets to provide security against bank debt. But given the challenges for AGL ahead of the demerger, Ord Minnett maintains a Hold and an $8.80 target.

The broker suspects retaining 15-20% ownership of AGL Australia implies Accel will most likely be unable to sell this stake.

By comparison, Credit Suisse views the 15-20% retained holding in AGL Australia by Accel as solely financial, and ultimately destined to be sold for an estimated $500-700m. The broker believes a capital structure which effectively raises up to $1.0bn, still leaves Accel unrealistically leveraged.

The broker retains an Underperform rating, a $6.80 target and anticipates further consensus earnings downgrades.

For now, the company has avoided capital raising considerations by terminating the Special Dividend Program and underwriting the FY21 final dividend and FY22 dividend. This decision is expected to raise $400-500m of additional equity.

While this may support an investment grade credit rating for AGL Australia and Accel Energy, UBS believe there is limited balance sheet capacity for both companies to fund growth.    

Given that 35% of generation volumes are to be market-linked from FY23, and 50% of volumes are fully merchant by FY26, Morgan Stanley views AGL's debt refinancing as a key demerger constraint.

The broker remains Underweight, and has a target price of $8.88.

Demerger pros and cons

Based on the capital structure of both entities, UBS also sees limited balance sheet capacity for AGL Australia and Accel to pursue growth ambitions. Adding to the broker’s concerns are earnings headwinds facing both companies in FY22 and soft returns for targeted wholesale markets growth projects.

UBS estimates total demerger costs of -$250m for one-off transaction costs and -$10m of ongoing dis-synergy costs. The sum of these costs translates to -$0.60/sh which the broker has already factored in the valuation.

The broker believes Accel’s debt capacity is limited by its $3.4bn liabilities related to environmental provisions ($1.4bn) and onerous contract provisions on legacy windfarm offtake agreements.

UBS supports the concept of coordinating Accel’s growth into low carbon industrial hubs to create synergies across supply chains. However, the broker is unclear what the returns these hubs will achieve.

Based on the projects in Accel’s development pipeline, Bells Mountain Pumped Hydro and 1.6GW of wind development projects, UBS remains skeptical of earnings growth from the company’s development pipeline.

Meanwhile, UBS sees limited material growth opportunities for AGL Australia into the medium term. But that said, the broker doesn’t see the balance sheet capacity to fund significant growth as it must carry the remaining $2.1bn which will see its funds from operations/net debt ratio in FY22 reduce to 13%.

Morgan Stanley assesses AGL investor upsides as non-zero, but also difficult to quantify. AGL anticipates dis-synergy costs, like systems, staffing, and funding will be offset by clarity benefits.

While it’s early days, Morgan Stanley sees clarity benefits as mixed. For example, while it will lead to a simpler capital budgeting frameworks within the separated entities, the broker believes the proposed retention of a 15-20% equity stake in AGL Australia potentially reduces the clarity benefit.

While AGL believes AGL Australia will benefit from fewer ESG exclusions compared to current AGL Energy, the broker’s industry channel checks suggest that the lack of identified decarbonisation additionality will remain a near-term pressure.

Morgan Stanley anticipates Accel Energy being excluded from many institutional mandates in view of its carbon intensity.

The consensus target combining six brokers on the FNArena database currently stands at $8.36, but Ord Minnett is yet to update.

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