AGL and Spark Infrastructure have had a strong run recently, and while some expect this to continue, their performance may be tempered by political and regulatory pressures.

Flat bond yields and ongoing defensive positioning by retail investors, as they seek to buffer stock market volatility, are among the main reasons for positivity on the sector.

Morningstar equity analyst Adrian Atkins believes this environment further bolsters the appeal of income-oriented stocks.

He says the outlook for lower global bond yields has been a key driver of the relatively strong share price performance of both AGL (ASX: AGL) and Spark (ASX: SKI).

“Weakening global economies would also see investors switch out of economically sensitive stocks into more defensive stocks [such as AGL and Spark]," says Atkins.

Bond yields have been relatively flat since early 2018, reflecting concerns that the Australian and global economies could be slowing.

Flagging global growth expectations from the International Monetary Fund, and the simmering US-China trade war further exacerbate these fears.

Over the six months to 31 January 2019, AGL's share price has eased 2.4 per cent, while Spark is up 5.6 per cent. In broader terms, the S&P/ASX 200 is down 6 per cent over this period.

Origin's (ASX: ORG) share price has fallen more than 25 per cent since mid-2018. This is largely due to the exploration and production company's exposure to oil price volatility, and its persistently high debt levels.

Despite the surge in wholesale electricity prices, consumers aren't expected to be slugged with higher costs, because of the intense political scrutiny of energy prices.

Moreover, any greater regulation of electricity prices and the increasing uptake of solar energy systems could threaten longer-term revenue streams. 

solar power

Rising solar uptake also poses a threat to power companies AGL and Spark

Prices spike as Australia sweats

Wholesale electricity prices have spiked this summer, as exceptionally hot conditions meant power demand outstripped supply in some parts of Australia, particularly Victoria and South Australia.

Andrew King, mid-caps portfolio manager with Perennial Value Management, believes higher wholesale power prices could be an earnings headwind, potentially denting energy company profitability rather than supporting it.

As such, his team is currently bearish on the sector. "We are of the view that the 100 per cent higher wholesale price won’t be passed through to the retail sector, thus you might see margin pressure," King says.

Morningstar’s Atkins agrees. “The utilities will struggle to push this through to customers via retail price increases, because of intense pressure from government and the potential threat of re-regulation and forced asset sales.”

Over the longer term, he says regulation remains a key risk to AGL, as the Federal Government tries to improve utility bill affordability. These measures include potential retail price regulation recommendations from the Australian Competition and Consumer Commission.

Threat may be overstated

“Overall, we're not too concerned by the ACCC's recommendations as they appear manageable, and we've long expected a regulatory response to rising utility bills.

"We believe the ACCC's retail recommendations will be effective, but downside is limited, while its wholesale recommendations shouldn't materially detract from generation earnings," Atkins says.

Power generation is a primary revenue driver for AGL, and Atkins doesn't believe the ACCC's small subsidy plans will be effective.

"High wholesale gas prices should keep wholesale electricity prices well supported, benefiting AGL's low-cost coal-fired power stations.

“Risk will build over the longer term, though, as the government is likely to try new ideas until it eventually succeeds in driving down generation profits,” says Atkins.

He has maintained fair value estimates of $20.00 and $2.40 for AGL and Spark, respectively. AGL's share price opened trading today at $21.90, and Spark's $2.50 share price at the open was almost level with Morningstar's FVE.

While Atkins believes political imperatives to keep prices low will pose ongoing challenges, a research note from Morgan Stanley suggests growing regulation is already priced into the utilities.

“The pipes, poles and wires in our stock coverage have faced significant regulatory pressure for the last two years, but we still view the regulatory framework as predictable and transparent," say Morgan Stanley equity analysts Rob Koh and Adam Martin.