AGL’s share price has continued to plummet in the face of on-going weakness in wholesale electricity prices, the poor state of the balance sheet and dubious corporate governance. But as the split of the company into the retail business AGL Australia and the generator Accel Energy approaches, we have relented on our Sell recommendation and upgraded it to a Hold.
There is little AGL could have done to avert the heavy toll of declining wholesale electricity prices in recent years, and perhaps not a great deal to offset the unwinding of the supernormal margins in the gas book. We have been watching the inevitable giant sink hole in AGL’s EBIT devour around $1 billion of earnings by the time FY22f is over, so it is disingenuous of AGL to say that no-one saw this coming.
Announcing the $620 million share buyback in August 2019 at around $20 per share was ill-advised at the time and remains so in hindsight. We note with wry cynicism that the Board has collectively purchased only 36k shares since then with the majority not even participating in the DRPs, and the current CEO has bought none.
Other than a cursory amount of loose guidance on the corporate cost split of the demerger between AGL Australia (60%) and Accel Energy (40%), there has been nothing else on the important cost separation. An unnecessary shift of HQ from Sydney to Melbourne where both CEOs live will not perceptibly improve anything.
Once the dismemberment is complete, it may become more apparent to investors where the value, if any, actually lies. Of course this is the intent of the separation but it will require some careful scrutiny due to the remediation provisions in Accel Energy. As a single company today, AGL is trading on about 5.7x FY23f EV/EBITDA but adding remediation provisions in at book value would add about 2.8x to that multiple.
Despite a 20% or so earnings decline over the last two years, AGL Australia will have appeal to some investors. At the current share price, if AGL Australia was worth 10x EV/EBITDA, then Accel Energy would be worth around 6x EV/EBITDA and just 2x ex-remediation. If we gratuitously ignore the unknown demerger costs and potential further dilution form the equity that needs to be raised, then at a pinch one could say those multiples are fair.
AGL Australia looks set to demerge with a balance sheet at around 4.5x net debt to EBITDA given that Accel Energy can only take about $800 million of the group debt. Among many issues, fixing the AGL Australia balance sheet post-demerger should be high on the agenda.
The fully underwritten discounted (1.5%) DRP should attract a 15-20% uptake. The lower end of that estimated range requires about $180 million of stock to be sold on-market in the 20-day window after 30 August 2021. Perhaps on top of that might be the ignominy of a removal of the stock from the MSCI Index adding to the selling pressure.
Investment view
Corporate governance issues have rendered AGL largely uninvestable for most institutional investors. But there is a process to unfold with the demerger and crucial financial information will become public enabling a cold light of day analysis. At this point, the risks appear more balanced so we have eased off our Sell recommendation noting the long fall of the share price. That is not to say the price fall is over, but we recognise the demerger could unleash some valuation support and therefore we change to a Hold recommendation.
