Should I buy AGL Energy (ASX:AGL)? Is it a safe haven amidst surging inflation

Should I buy AGL Energy (ASX:AGL)?

That’s a question many investors would be forgiven for asking themselves when hearing that electricity prices are skyrocketing (yet again) in FY24.

Consumers may cut back on energy usage, but they cannot avoid spending altogether. They may shop around for better deals, but in all seriousness good luck to them because they’re going to need it.

AGL is up 36% in 2023 so far, making it one of the best performing stocks in the ASX 200. But it is still well off all time highs seen in the 2010s. So is there more room to run?

Spoiler Alert: Perhaps in the short-term, but investors thinking AGL is as safe as gold or CSL (ASX:CSL) would have short memories.

 

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Who is AGL Energy?

AGL is a generator and seller of electricity and gas to Australian households and businesses. In fact, it is the largest of its kind in Australia

Here’s a bit of history to use at (investor) trivia nights: It was the second company to list on the Sydney Stock Exchange, joining as the Australian Gas Light Company.

Now for some ESG trivia: It is Australia’s largest carbon emitter, accounting for 8% of Australia’s national carbon footprint.

 

From a circus to champagne?

2022 was a horrible year for the company. Mike Cannon-Brooks and a consortium led by him tried to take over the company.

The reason he tried to take over the company was because he had different ideas as to how AGL could shake off its identity as a major carbon emitter. The board conceived plans to split its coal business into a separate entity named Accel Energy.

Before it could put the plans to shareholders for a vote, shareholder pressure led to the company not even putting the question to them. The scuttling of the plans led to four board members resigning and the company to undertake a strategic review of its operations.

Even after all this was over, scars remained. The company will have major capex requirements over the next decade to achieve Net Zero by FY35. It would require up to $20bn in place before 2036 funded from assets on its balance sheet, offtakes and via partnerships.

Sometimes investors can overlook boardroom dramas if the company is delivering for shareholders, but AGL was not. It made a 1HY23 loss of over A$1bn, hindered by extended outages at its ageing Loy Yang A and Hunter Valley power plants.

 

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Is the future rosier?

Since Easter companies left right and centre admitting to shareholders customers are cutting back spending and their share prices are dropping like flies.

Investors are desperate for safe havens – companies that will not experience declining demand or declining margins, preferably being able to do so while just servicing their customers as usual.

Sorry big banks, but investors don’t like the fact that you had to offer significant cashback offers and discounted interest rates to stop mortgagees breaking up with you and refinancing with a larger bank.

But a trading update out of AGL Energy roughly two weeks ago gave investors hope that safe havens may yet exist.

The company narrowed its FY23 earnings guidance to the higher points. It expects underlying EBITDA to be $1,330-$1,375m when it previously guided to $1,250-$1,375. And underlying profit after tax is expected to be $255-$285m when the previous range was $200-$280m.

Why was this? The company told shareholders it was higher margins, increased customer services and a reduction in forced outages. AGL noted this was partly offset by higher operating costs due to increased maintenance costs, inflation and a seasonal net bad debt expense.

But the best news of all was guidance for FY24. It is expecting underlying EBITDA of $1,875m-$2,175m and underlying profit of $580-$780m.

Let’s assume AGL reached the mid point for both FY23 and FY24 guidance. Underlying EBITDA would be up 49.8% and underlying profit would be up 183%!

The cherry on the cake was news the company may be paying dividends again soon. It told shareholders it ‘may begin to pay partly franked dividends from the interim FY25 dividend’ (post 1HY25 results which are due in February 2025). Its policy is to pay out 50-75% of underlying profit after tax.

As we noted above, shares are up 36% this year. Although it was climbing prior to mid-June, shares have seriously gained momentum after the most successful investor day in several years.

 

 

It may still be undervalued

Despite the share price growth in CY23, AGL is still well behind its all time highs. And it is trading at just 10.7x P/E for FY24 with a PEG of just 0.33%!

If you consider the average P/E for an ASX 200 stock is 15.7x and apply that to AGL, this derives a share price of $16.33 – a 50% premium to its intraday price on Thursday June 22 2023.

On a DCF basis, we think it is $15.51 – a 42% premium. We have used consensus estimates and a WACC of 8.79%.

Nonetheless, the 13 analysts covering AGL (despite agreeing with the company’s guidance for FY23 and FY24) only have a median share price of $11.38 – a mere 4% premium.

Why is this? This is because revenue growth will be slower. They expect just 5.4% growth in FY23 and just 3.5% in FY24. After peaking at $14.5bn in FY25, they expect revenues to retreat thereafter, only expecting $13.4bn in FY26.

Although EBITDA and EPS aren’t predicted to plunge, they are expected to stagnate after FY25. Obviously, AGL will have to close down polluting assets and generate capex for new energy initiatives somehow.

For now, it appears investors are overlooking the longer-term, happy for anything that has minimal chance of a 20-30% share price plunge on account of an earnings downgrade.

However, given the bar has been set high for AGL, it may merely require slower bottom line growth to see a share price plunge.

 

So should I buy AGL shares?

In the short-term (the next 12 months or so), investors may want to consider AGL, especially if their portfolio is heavily weighted to riskier segments of the market – consumer discretionary stocks and tech.

In the longer-term, we remain uncertain as to the company’s transition from being the largest polluter to another Net Zero firm.

Specifically, how it will be funded, whether it can be achieved on time and whether or not it can maintain the top and bottom lines while doing so.

So investors who buy in need to have an exit strategy planned. And as we always say, no stock portfolio should be in just one company or sector. A portfolio must be well balanced between different sectors, companies and even different assets, to give investors the best possible chance of netting returns.

 

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