AGL has had a tough few years.

Since peaking in 2017, its share price has slipped 67% - and that’s after a recent rally lifted AGL shares 27% since March.

But the company is on the road to recovery, according to Morningstar senior equity analyst Adrian Atkins, and currently offers great value for investors wanting a defensive asset – something that’s difficult to find in the current uncertain environment.

The outlook for AGL (ASX:AGL) was a topic of discussion in our latest ‘Ask the Analyst’ webinar, with Morningstar readers keen to learn about the company’s business model as it transitions away from a key source of revenue – coal fired power generation.

Here’s what investors wanted to know.

Why is AGL one of Morningstar’s best ideas?


AGL is one of 12 ASX companies to rank on Morningstar’s global best ideas list – available in full to Investor subscribers – which aims to identify high-quality companies  trading at discounts to their assessed fair values.

Atkins says despite disappointing earnings in the current financial year, the rebound in electricity prices should underpin a strong recovery in fiscal 2024.

“For AGL, [earnings] will be driven by stronger retail electricity prices, they're going up by about 20% in most states on the first of July. So that's going to be a massive boost to their earnings,” he says.

Trading in 4-star territory, AGL shares sit at a 32% discount to Morningstar’s fair value estimate.

“Even after the recent share price rally it's still on a price-to-earnings ratio of about 9 with a big yield, so we think that's attractive.”

How does Morningstar view the future of AGL’s business model?


Despite AGL being a major producer of energy – and generating most of its earnings through its low-cost thermal generation capacity – Atkins says this wasn’t always the way.

“It only bought those big coal fired power stations about 10 years ago,” he says.

AGL last month retired its Liddell Power Station after more than 50 years of operation, with plans to repurpose the site into an industrial renewable energy hub with large-scale battery and potentially solar and hydrogen generation.

But Atkins says AGL’s position as an energy producer will likely change.

“As time goes by and these big power stations close down, I don't think AGL will still be a big producer for electricity,” he says.

“It's not going to replace all those coal power stations with wind farms and solar farms, and the reason for that is that there's a huge number of companies out there that want to build wind farms and solar farms.

“With all that competition the returns from building them is actually quite low.”

Rather, AGL will leverage its big customer base to negotiate with third party wind and solar farms for long term power supply contracts.

“AGL will build more batteries and it'll build more gas-fired peaking power stations to fill in the gap when the solar and the wind farms aren’t producing enough power,” he says.

“That way they can package up steady electricity to sell to customers, so it'll still have a very vital position, but it won't necessarily be producing all of the power itself.

“They've got to invest in the things where they've got competitive advantages and building wind and solar farms, no one really [has a competitive advantage], it's a very competitive business.”

Will AGL return to paying attractive dividends?


AGL’s dividend has been hit hard in recent years, in line with declining earnings, given it runs a payout of 75% of underlying earnings.

Atkins says strong forecast earnings in FY24 will see dividends improve – however over the medium term, AGL may move to lower its payout ratio.

“Dividends should go up just because earnings are going to go up by so much in FY24. But I think AGL will take the opportunity to reduce the payout ratio, just so they can save that money and reinvest it into batteries, into seeding wind farm and solar farms, into their energy hubs,” he says.

“So they've got a lot of money to spend to transition, and as such that they can't really afford to pay out a massive payout ratio.”

AGL has been through a period of disruption, is it over?


Environmental, social and governance issues have plagued AGL in recent years, from political pressure to extend the life of its Liddell power plant, to activist investors derailing its demerger plans, driving a board shakeup and calling for a faster transition away from coal – led by Atlassian (TEAM) co-founder and billionaire Mike Cannon-Brookes.

But Atkins says stability appears to have returned to the company.

“It was a really awful time for AGL, there was a lot of disruption, a lot of new members to the board. There was also a lot of fairly senior staff leaving the firm,” he says.

“But that has all calmed down now and the business, from all I can tell, is getting back to building itself up again and steadying the ship.

“There's been a lot of questions about whether these extra board members are really looking after shareholders, and the feedback I get back from investor relations is that definitely their main goal is to look after shareholders, but they just do it with a bit of a different lens.”

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