We added AGL Energy (ASX: AGL) to our Global Equity Best Ideas list. The shares trade at a discount to our fair value estimate. Earnings have recovered, and the long-term outlook is relatively stable, as investment in renewables and batteries offsets headwinds from the closure of coal-fired power stations.

We expect electricity prices to remain elevated, supported by the closure of coal power stations, high gas prices, and growing electricity demand as transport and other industries electrify. These factors support a solid earnings outlook. Financial health is sound, and management is doing a good job navigating ESG threats.

Our view of AGL shares

AGL Energy is one of Australia’s largest integrated energy companies. Earnings are dominated by energy generation (wholesale markets), with energy retailing contributing just a fifth of operating earnings. Strategy is heavily influenced by government energy policy, such as the renewable energy target.

AGL Energy’s consumer market division services over 4 million electricity and gas customers in the eastern and southern Australian states, representing roughly a third of available customers. Retail electricity consumption has barely increased since 2008, reflecting the maturity of the Australian retail energy market and declining electricity consumption from the grid. Despite deregulation and increased competition, the market is still dominated by AGL Energy, Origin Energy, and Energy Australia, which collectively control three fourths of the retail market.

AGL Energy’s wholesale markets division generates, procures, and manages risk for the energy requirements of its retail business. Exposure to energy-price risks are mitigated by vertical integration, peaking generation plants and hedging. More than 80% of AGL Energy’s electricity output is from coal-fired power stations. AGL Energy has the largest privately owned generation portfolio in the National Electricity Market.

AGL bulls say

  • As AGL Energy is a provider of an essential product, earnings should prove somewhat defensive.
  • Its balance sheet is in relatively good shape, positioning it well to cope with the renewable transition.
  • Its low-cost coal-fired power stations underpin solid earnings for the group.

AGL bears say

  • The regulatory environment is unpredictable and has a significant impact on AGL Energy’s earnings.
  • AGL Energy’s gas costs are rising as cheap legacy supply contracts end.
  • Banks plan to phase out lending to coal power stations in the 2030s.

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Terms used in this article

Star Rating: Our one- to five-star ratings are guideposts to a broad audience and individuals must consider their own specific investment goals, risk tolerance, and several other factors. A five-star rating means our analysts think the current market price likely represents an excessively pessimistic outlook and that beyond fair risk-adjusted returns are likely over a long timeframe. A one-star rating means our analysts think the market is pricing in an excessively optimistic outlook, limiting upside potential and leaving the investor exposed to capital loss.

Fair Value: Morningstar’s Fair Value estimate results from a detailed projection of a company’s future cash flows, resulting from our analysts’ independent primary research. Price To Fair Value measures the current market price against estimated Fair Value. If a company’s stock trades at $100 and our analysts believe it is worth $200, the price to fair value ratio would be 0.5. A Price to Fair Value over 1 suggests the share is overvalued.

Moat Rating: An economic moat is a structural feature that allows a firm to sustain excess profits over a long period. Companies with a narrow moat are those we believe are more likely than not to sustain excess returns for at least a decade. For wide-moat companies, we have high confidence that excess returns will persist for 10 years and are likely to persist at least 20 years. To learn about finding different sources of moat, read this article by Mark LaMonica.