AGL at a glance: 

  • Fair value estimate: $12.80
  • Morningstar rating: 4 stars
  • Morningstar uncertainty rating: High
  • Morningstar economic moat rating: Narrow

Narrow-moat AGL Energy's (AGL) investor day on Friday highlighted its recovery is well underway.

AGL Energy is one of Australia's largest integrated energy companies. We believe it has a narrow economic moat, underpinned by its low-cost generation fleet, concentrated markets, and cost-advantages from vertical integration. Earnings are dominated by energy generation (wholesale markets), with energy retailing about half the size. Strategy is heavily influenced by government energy policy, such as the renewable energy target.

 

On Friday, AGL's fiscal 2023 net-profit-after-tax guidance range was narrowed and increased by 13% at the midpoint and fiscal 2024 guidance was given for the first time, portending a strong rebound broadly in line with our expectations.

The stock still screens as slightly undervalued despite the strong rally in recent months, trading on a forecast fiscal 2024 price/earnings ratio of 11 and offering a dividend yield of 5.4% based on the current share price.

Dividend franking will likely return in fiscal 2025, a little later than we previously expected.

Earnings to accelerate on higher power prices


Headwinds intensified for AGL as average wholesale prices dropped to just AUD 40 per megawatt hour, or MWh, in early 2021. Lower wholesale electricity prices, lower carbon credit prices and rising fuel costs drove underlying net income to just AUD 225 million in fiscal 2022. But electricity prices have since recovered and the medium-term outlook is good. 

Improved fiscal 2023 guidance reflects a solid second-half performance on the back of increased power station reliability and growth in retail customer numbers and profits margins.

Earnings are set to accelerate in fiscal 2024, mainly as high wholesale electricity prices pass through to residential and business customers. Earnings should also benefit from the startup of grid-scale batteries in Adelaide and Broken Hill and, hopefully, the nonrecurrence of major power station outages.

These positives are expected to be partly offset by higher bad debts and support for struggling customers, increased maintenance spending on power stations, and general cost inflation.

With the refinancing of AUD 1.6 billion debt in April demonstrating ongoing support from lenders, and management confirming an anticipated profit recovery in fiscal 2024, we think key investor fears have been allayed.

Further, management provided a long-term expectation for NPAT in fiscal 2036 to be similar to fiscal 2024 as investments in batteries and renewable energy, and growth in retail profits offset the closure of coal power stations.

AGL screens as undervalued


Our fair value estimate for AGL Energy is AUD 12.80 per share.

Our valuation is underpinned by our view that wholesale electricity prices will be well supported for at least the medium term. Average wholesale electricity prices in eastern states recovered strongly since the 2021 lows. Higher wholesale prices will take time to flow through to customer contracts and thus AGL Energy's profits.

We believe recovery has been partly caused by rising gas prices increasing operating costs for gas-fired power stations and unplanned outages, supporting our thesis.

We expect electricity prices to remain supported by closure of the Liddell power station in 2023 and tightening Victorian gas supply as gas fields deplete.

Investor subscribers can view the full analysis on AGL here.