Morningstar Investor users sign in here.

Markets

Is AGL between a BlackRock and a hard place?

The undervalued Australian energy provider is unlikely to heed the call to hasten the shut down of one of its best assets.

Mentioned: AGL Energy Ltd (AGL), Link Administration Holdings Ltd (LNK)


If you can stomach the wait and are not bothered by investing in coal, there’s a 20 per cent odd discount to be had in energy provider AGL at the moment. And despite a cut to its earnings forecast, it has a healthy balance sheet and offers a solid longer-term dividend.

AGL, the oldest company on the ASX, copped a bit of a black eye at its AGM this week. Alongside outcry over exec pay, another question emerged: will Australia’s largest energy provider AGL bow to pressure from the world’s largest asset manager and hasten the closure of one of its key coal assets?

One of its top five shareholders, BlackRock, the world’s largest asset manager, called on AGL to hasten the closure of its low-cost coal-fired plant, Loy Yang A, in Victoria. That’s in keeping with the $7.3 trillion fund giant’s move earlier this year to dump some coal stocks. Incidentally, this begs the question, why are they still one of AGL’s top shareholders? BlackRock says AGL’s own analysis shows it could close the plant 12 years ahead of schedule and that leaving it open until 2048 presents increasing safety risks.

Whether AGL accedes to calls to shut Loy Yang, remains to be seen. Morningstar senior equity analyst Adrian Atkins admits Loy Yang is old but that it nevertheless underpins AGL’s narrow moat rating, implying a ten-year competitive advantage for the company.

“Do you really want to shut down one of your best assets?” Atkins says. “If you do, what have you got left that’s moat worthy? Loy Yang produces about one third of Victoria’s electricity needs and has the lowest running costs of thermal generation in the Australian National Electricity Market. This low-cost position is unlikely to be displaced any time soon. Loy Yang owns huge brown-coal reserves capable of powering the plant until its scheduled closure in 2048, insulating it from commodity prices.”

Atkins says any early closure will depend on commercial considerations such as the wholesale electricity price, which is currently well below his long-term forecast. As AGL boss Brett Redman noted this week, in Victoria, futures contracts are trading at about $45 per megawatt hour for 2022 and 2023. That's a fall from an average of about $75 over 2020.

Atkins has cut his medium-term earnings forecasts because of the lower expected wholesale prices and his fair value estimate by 3 per cent to $17.50. At midday on Friday, AGL was trading at $13.42—a 23 per cent discount to Atkins’ FVE. The share price is down more than 50 per cent from the 2017 peak and is now unchanged over the past 10 years.

“Despite trimming our valuation, we consider AGL attractively priced,” Atkins says. “Based on the current share price, we forecast an average dividend yield of 5.5 per cent over the next five years, with solid longer-term dividend growth as earnings recover. Dividends should be mostly franked except for during the next two years as historical tax losses reduce tax payments.” To read more about the profit drivers and risks—such as the government’s renewable energy targets—for AGL click here.

AGL Energy (AGL) – 5YR

A chart showing the share price movement of AGL Energy over ten years

Source: Morningstar Premium

In Firstlinks this week, Graham Hand got a copy of the budget papers and dog-eared a few pages in particular, namely those on the proposed superannuation comparison tool YourSuper. Josh Frydenberg argues this will save us $17.9 billion over ten years. Hand, however, sees a political pitch based on an unrealistic dream.

Hand also speaks to Vivek Bommi of Neuberger Berman, who shows how fixed interest and stock markets bailed out companies facing the pandemic, and how high-yield bonds are attracting flows in the current market.

Elsewhere, Morningstar personal finance director Christine Benz has some succinct advice for drawing up an investment strategy. Hint: it should be concise enough to fit on an index card.

Will a turbulent US election derail recovery? As the Trump-Biden showdown nears and vaccine trials continue, headlines may lead to volatility, but Morningstar equity analyst Dave Sekera expects the economic rebound to keep on.

Companies that address the growing demand for decarbonisation will have a 20-year growth opportunity, says Nick Griffin of Munro Partners. We sat down with him to shake out a few investment ideas.

Vikram Barhat looks at three gaming companies worth betting on; James Gard proposes four reasons why bonds may be worth your time—and investment, and Nicki Bourlioufas examines why large-cap returns have outpaced those of small caps. And look out next week for Bourlioufas's survey of ASX names that stand to benefit from the budget.

Holly Black talks to Morningstar analyst Chelsey Tam on the historic IPO of Ant Financial Group and what you need to know about the $49 billion listing.

Emma Rapaport reports from the Morningstar Investor Conference, where keynote speaker, the Grattan Institute’s chief executive Danielle Wood, posed the question: Can fiscal policy provide the post-covid economic boost that monetary policy no longer can? Rapaport also looks at what Link Adminstration stands to gain from its investment in online conveyancing provider Pexa.

And finally, in Your Money Weekly, Peter Warnes notes the recovery appears to be now more of a grind as momentum fades. “With no progress on further stimulus the risk is consumer spending, the key driver of economic activity, could weaken,” Warnes writes.

“Early estimates of 3Q GDP suggest growth at an annual rate of 30 per cent plus which would restore about 90 per cent of the 31.4 per cent contraction in 2Q. To get back to pre-coronavirus levels 3Q GDP would have to grow at an annual rate of almost 54 per cent.”

 

Morningstar's Global Best Ideas list is out now. Morningstar Premium subscribers can view the list here.



© 2023 Morningstar, Inc. All rights reserved. Neither Morningstar, its affiliates, nor the content providers guarantee the data or content contained herein to be accurate, complete or timely nor will they have any liability for its use or distribution. This report has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or New Zealand wholesale clients of Morningstar Research Ltd, subsidiaries of Morningstar, Inc. Any general advice has been provided without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide at www.morningstar.com.au/s/fsg.pdf. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Our publications, ratings and products should be viewed as an additional investment resource, not as your sole source of information. Morningstar’s full research reports are the source of any Morningstar Ratings and are available from Morningstar or your adviser. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a financial adviser. Some material is copyright and published under licence from ASX Operations Pty Ltd ACN 004 523 782.

More from Morningstar

Global Markets Report - 6 December
Markets

Global Markets Report - 6 December

ASX set to open higher, while US stocks continued to pull back from their late-November rally.
Global Markets Report - 5 December
Markets

Global Markets Report - 5 December

ASX set to open lower, after all three major US indices lost ground.
Outlook 2024: How to take advantage of AI without valuation risk
Markets

Outlook 2024: How to take advantage of AI without valuation risk

Be smart about your exposure to AI and avoid overpriced assets
Global Markets Report - 4 December
Markets

Global Markets Report - 4 December

ASX set to open higher, after the Dow, S&P 500 finished at highest levels since early 2022, US treasuries continued lower.
Global Markets Report - 1 December
Markets

Global Markets Report - 1 December

ASX set to open lower, while US major indices break a three-month losing streak for November.
Global Markets Report - 30 November
Markets

Global Markets Report - 30 November

ASX set to open higher, after a mixed day for US major indices and bond yields continued to move lower.