Is AGL between a BlackRock and a hard place?

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

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.

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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.