2 differing views on these utility, energy stocks
Equity analysts have divergent views on AGL Energy, Origin Energy, Alinta and Woodside Petroleum, with pockets of value amid the problems, writes Nicki Bourlioufas.
Equity analysts have divergent views on AGL Energy (ASX: AGL), Origin Energy (ASX: ORG), Alinta and Woodside Petroleum (ASX: WPL), with pockets of value amid some problems.
Utility stocks may represent some value, with AGL Energy tumbling in the past year given falls in wholesale electricity prices. But the outlook is bright for the utility, and even the entrance of a new competitor poses no threat to its narrow economic moat, according to Morningstar equity analyst Adrian Atkins.
Atkins is less upbeat on heavily indebted Origin Energy, which he believes is a riskier investment. Atkins says AGL is fairly valued at about $22, with a forecast fiscal 2019 price-earnings ratio of 13-times and a 5.8 per cent mostly franked dividend yield. The company has a narrow economic moat, underpinned by its low-cost coal-fired power stations, concentrated markets and cost advantages from vertical integration.
"Key attractions for shareholders include defensive earnings, regular dividends and low gearing … Strong operating cash flow enables payment of reliable mostly franked dividends, an enhanced attraction in a low interest-rate environment," says Atkins.
Despite deregulation and increased competition, he still sees AGL as a dominant player in the space, alongside Origin Energy and Energy Australia. The trio controls three-quarters of the retail [gas and electricity] market.
The outlook is bright for AGL Energy, Morningstar says
"As AGL Energy is a provider of an essential service, earnings should prove defensive. Increases in retail energy prices should underpin strong profit growth in coming years, despite some margin pressure from competition," Atkins says.
While Alinta Energy's entrance into east coast markets will put pressure on retail energy prices and may erode some of AGL's market share, Atkins says AGL will maintain its narrow moat. Alinta is reportedly targeting 400,000 customers across the east coast by the end of the year, compared to AGL's 3.6 million customers, Origin's 4.2 million and Energy Australia's 2.6 million.
"Our longer-term earnings forecast is largely unchanged, and we maintain our $21 fair value estimate.
"AGL's narrow moat is intact, with cost advantages stemming from its low-cost coal-fired power stations, vertical integration and scale," Atkins says.
The company's share price fell from more than $28 in early 2017, as the outlook for strong growth in retail prices dissipated and wholesale electricity prices returned to normal. Wholesale prices fell from their highs of more than $150 per megawatt hour (MWh) in 2017 to about $70 per MWh in NSW this year. Other states showed a similar trend. In response, Atkins has lowered by 5 per cent his profit forecasts for AGL in 2018-19 and 2019-20.
No moat, lower confidence
Atkins is less sanguine about Origin Energy, with a fair value estimate of $7.50, compared to Origin's current price around $9.50, which has lifted with oil. Unlike AGL, Origin Energy has no moat. The principal risk the company faces relates to high debt.
"We remain cautious over Origin's exposure to volatile oil and gas prices combined with still high debt levels. Debt to earnings before interest, tax, depreciation and amortisation (EBITDA) should be around 4 times in fiscal 2018, which is much more aggressive than peer AGL Energy at 1.7 times," Atkins says.
"Origin's share price is likely to keep rising if oil prices stay strong, but we prefer AGL because of its lower risk profile and solid, mostly franked dividend yield," says Atkins.
Liddell shutdown
Atkins defends AGL's controversial decision to shut down the Liddell coal-fired power station as a fair one as the power station was ageing and costly to maintain. The company recently rejected a bid from Alinta to buy Liddell and confirmed it would shut the facility in 2022. AGL will instead invest in renewable energy production, including in batteries, as well as quick-start gas power stations and upgrading other coal power facilities.
Another stock that has rallied this year, in the context of oil prices, is Woodside Petroleum. While many stockbrokers back in February had price targets of about $30, its price surged beyond that level this month to a high of $34.73 and is trading at about $32.
While liquefied natural gas markets are currently oversupplied, Woodside believes the market will be in deficit from 2023 onwards. The company is investing in its Scarborough and Pluto projects to the tune of US$6.8 billion to US$7.9 billion ($8.9 billion to $10.4 billion).
"Our view is that this development will be positive for Woodside over the medium term as it increases production and creates certainty regarding the future for Woodside in the face of a declining resource base," says DJ Carmichael analyst Michael Eidne.
"There may be some short-term volatility as the market digests the [$2.5 billion] cap raise but this will be short term in our view and may create a buying opportunity."
According to another broker, Morgans, which has a $30.99 target on Woodside, "we see long-term fundamentals for LNG as strong, but remain cautious given the size of the bets being made by Woodside in Scarborough and Browse [LNG project]."
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Nicki Bourlioufas is a contributor for Morningstar Australia.
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