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.
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
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